ITEM 1. Business --------
GENERAL
Nestor, Inc., and its wholly owned subsidiary Nestor Traffic Systems, Inc. (together the "Company"), provides traffic safety solutions and services to states and municipalities. The Company's products combine sophisticated digital and analog video technologies with advanced image-processing to detect and interpret a wide range of traffic-related elements and conditions. Using the captured video images, Nestor applies proprietary neural network predictive models and other algorithms to convert existing data into meaningful recommendations and actions. This advanced technology, which effectively sees and interprets objects captured in video images, is at the core of each product solution. These products are a combination of Nestor-developed software and modular hardware components that provide monitoring for traffic-data collection, control of traffic flows, enforcement and emergency response. These products are flexible and can be configured to a wide range of road configurations, including open roads and intersections. The Company's systems offer an array of features and unique functionality that address critical transportation management and traffic safety needs. The Company formerly developed and marketed products in the fields of risk management, customer relationship management and character recognition.
The Company is currently devoting its resources to its core product, CrossingGuard(R), and expects that all material revenue will come from CrossingGuard or associated products and services. Offered as part of a turnkey system for automated red light enforcement, CrossingGuard(R) is tailored to meet clients specific needs, including intersection analysis, hardware and software installation, user training and support, and backroom processing. The CrossingGuard system provides a unique combination of aboveground vehicle detection, multiple time-synchronized videos, and a collision avoidance safety feature.
Exclusive rights in the field of traffic-management solutions were granted Nestor Traffic Systems, Inc. (NTS) on January 1, 1997; co-exclusive rights in the field of Risk Management and non-exclusive rights in the field of Customer Relationship Management Systems (CRM) are held by Applied Communications, Inc. (ACI) and Retail Decisions, Inc. (ReD); and non-exclusive rights in the field of Intelligent Character Recognition Systems (ICR) are held by National Computer Systems, Inc. (NCS). IBM has non-exclusive rights to incorporate Nestor's technology into hardware products known as the ZISC family of computer chips.
NTS is an emerging leader in providing innovative, video-based monitoring systems and services for traffic management and safety. NTS incorporates patented pattern-recognition technologies into intelligent, real-time solutions that promote traffic efficiency, intersection safety, and railway grade crossing monitoring and safety. In the past, NTS has developed and marketed CrossingGuard(R), Rail CrossingGuard(R), and TrafficVision(R). These products are a combination of Nestor-developed software and modular hardware components that provide monitoring for traffic-data collection, control of traffic flows, enforcement and emergency response. These products are flexible and can be configured to a wide range of road configurations, including open roads and intersections.
In June 2002, the Company underwent a significant restructuring involving management changes and cost control to lower personnel and facilities expenses as the Company refocused its efforts solely on its red-light video enforcement contracts for CrossingGuard(R) installations. The Company terminated 19 full-time employees, affecting all departments, and offices were consolidated into smaller facilities.
Information about the industry segments and geographic areas in which the Company operates can be found in Note 11 to the financial statements included in this report.
PRODUCTS
The Company's traffic enforcement products use high speed image processing and target-tracking technology applied to real-time video scenes. The products use software and video cameras to detect red light violators at signalized intersections.
CrossingGuard(R). CrossingGuard is an automated, video-based monitoring system that predicts and records the occurrence of a red light violation. The software, through a video camera, tracks vehicles approaching an intersection. Based on the vehicle's speed, acceleration, and distance from the intersection, the system predicts whether a red light violation will occur. If a violation is expected to occur, the system can send a signal to the traffic controller to request a brief extension of the red phase for cross traffic. This helps prevent a collision between the violator and vehicles in the cross traffic accelerating on a green signal. The system simultaneously records the violation sequence, including a close-up of the vehicle and license plate, and transmits video evidence electronically to the police department, which reviews the violation and issues a citation. Citation mailing and other back-office services are provided by the Company.
The Company provides a complete turnkey solution, offering violation review, citation preparation and processing, billing and collection, court scheduling, evidence, and resolution. In addition, the Company provides direct, remote, and online equipment monitoring and maintenance primarily through its field and office personnel and through local contractors as necessary.
The CrossingGuard system consists of a video camera installed on top of a traffic signal pole or a roadside pole installed by the Company used to track approaching vehicles and record the actions of an approaching violator. Another camera is positioned so as to see the signal heads as they change from green to yellow to red and record the vehicles actions as the lights change and it enters the intersection. The views from these two cameras can also be presented in a side-by-side synchronized mode to demonstrate the complete view of the violation, including extenuating circumstances, aggressive behavior, or other factors. Finally, an enforcement camera is positioned to obtain a close-up image of the vehicle license plate, and where needed the driver image, based upon vehicle location instructions provided by the tracking camera. A personal computer is installed in an enclosure by the wayside, or remotely if a fiber connection to the roadside is used, that runs the intelligent software and controls camera activity. High-speed communications transmit video and data from the intersection to a designated facility for processing. The facility is equipped with a CrossingGuard Server PC that receives and stores violation data and supports authorized viewing of violation video sequences.
CrossingGuard is built upon standard PC hardware and software components. This design provides the reliability and performance benefits of improving PC hardware and the ability to upgrade and add functionalities as needed. The Company purchases components from third party vendors, built in accordance with Nestor's specifications, and the systems are installed by local contractors.
CrossingGuard VIP. The CrossingGuard Video Intersection Profiling (VIP) program is a proprietary tool that the Company has developed to help municipalities pre-qualify intersections. Since intersection violation rates can range from an average of a few per day to over fifty per hour, the system helps the municipality develop an estimate of safety issues at a given intersection and the long-term ticket volume by counting and profiling violations for all directions at a particular intersection.
CrossingGuard Services. CrossingGuard Services is the complete package of services and support that can be customized to a client's needs. It consists of site planning and equipment installation, equipment maintenance, user training and support, violation review, citation preparation and processing, fine collection and processing, account management, toll free hotline support, public education, and expert testimony.
The economics of the CrossingGuard product are tied to the number of violations processed by the systems and the number of operating systems in the field. Most contracts compensate NTS on a per ticket paid or issued basis in return for both equipment lease, maintenance and back office services. Generally, but not in all cases, the contracts require a monthly minimum fee designed to allow NTS to recover the value of the system delivered, including a finance factor and maintenance costs, over the term of the contract. During 2003, there has been a trend by states towards fixed monthly fee as opposed to variable per ticket fee pricing structures.
As of December 31, 2003, NTS had 90 approaches installed and generating citations, including two pilot program approaches, and an additional 47 approaches under contract and in various stages of delivery. In March 2004, NTS executed a new contract for up to an additional 40 approaches (20 intersections). No assurances can be given that all approaches under contract will ultimately be installed. The Company realizes from $25 to $97 per citation
issued or paid or fixed monthly fees ranging from $4,000 to $12,000 per approach for system delivery and lease, maintenance, software licensing, and processing services, depending upon state statutes regarding driver versus registered owner liability for a violation. Driver liability statutes require the driver be identified in the photographic evidence and the citation be sent to the identified driver. Registered owner statutes identify the vehicles owner, through DMV records, as the responsible party for a violation. As only the license plate is required for identification, program operating efficiencies are much higher resulting in lower per citation or monthly fees to cities. Current trends in the industry are towards compensating red-light program vendors on a fixed fee basis instead of a variable fee basis tied to ticket volumes. Actual results from deployment of CrossingGuard systems are expected to fluctuate substantially depending upon intersection selection and configuration, driver response to installed systems, and many other factors. Minimum monthly fee and fixed monthly fees would reduce the risk of fluctuations in citation capture and issuance rates.
During 2003, NTS realized $2,677,000 in CrossingGuard related revenues, a 217% increase over the $844,000 earned in 2002 due to the increase in installed approaches during the respective periods.
Status of the CrossingGuard market. Ineffective red-light safety enforcement is a costly and growing problem that until recently has been largely unaddressed by technology solutions. There are an estimated 300,000 intersections with traffic signals in the United States where approximately 218,000 collisions and as many as 181,000 injuries and 880 deaths occurred as a result of red-light running as per Federal Highway Administration 2001 statistics. First-generation Red-Light Camera Systems gained early acceptance as a means of automated traffic enforcement. While these systems have validated the market opportunity, they generally continue to rely on in-ground vehicle sensors ("loops") and still photography and have become inferior solutions because of their (i) significant roadbed installation issues, (ii) high maintenance requirements, and (iii) general lack of functionality.
The use of cameras to enforce red light running violations requires specific authority at the state or local government level (state statutes or home rule statutes). To date, approximately 15 states, including the District of Columbia, have authorized on a full or limited basis the use of red light cameras. Recent studies have shown these systems to be effective in reducing red light running at enforced intersections, and a positive halo effect at surrounding unenforced intersections. The Federal Highway Administration and other organizations have recently acknowledged these systems as positive tools in the reduction of red light running and correspondingly the number of accidents. However, there remains opposition to these systems, largely based upon concerns regarding individual privacy rights and due process rights. Many additional states and communities have or are considering authorization of cameras but need to address these minority concerns first. The Company believes that the overall trend is towards expanded state authorization of camera based red light enforcement systems, and eventually speed enforcement systems, but it is difficult to estimate when these changes may occur. The Company also believes that business opportunities from the currently authorized communities will be enough to support near term growth objectives.
Rail CrossingGuard. NTS developed Rail CrossingGuard, a system to monitor grade-crossing vehicle and train traffic, as well as signalization activity, to provide grade-crossing-integrity measurement, real-time crossing alert capabilities and crossing violation enforcement. This product has the potential to enhance rail-crossing safety by improving signal and crossing gate monitoring, alerting personnel to dangerous crossing situations, and enforcing train and vehicle safety regulations. Rail CrossingGuard may also be integrated with train communications systems to provide a method of alerting trains to dangerous rail crossing conditions.
On April 1, 2001, NTS completed its first Rail CrossingGuard installation in DuPage County, Illinois and had completed design work necessary to commence construction on the delivery of five Rail CrossingGuard units in Florida. In addition, NTS had received a contract from the Federal Railroad Administration (FRA) to develop a portable Rail CrossingGuard unit for non-permanent data gathering capabilities. Also, NTS, working with GeoFocus, Inc., a Florida company, won a contract to expand two of the Rail CrossingGuard units in Florida to incorporate remote communication capabilities between Rail CrossingGuard units and train operators. During 2003, NTS realized $10,000 in Rail CrossingGuard related revenues as compared to $426,000 in 2002. During 2002, the Company reduced its marketing and sales efforts in this product line to focus its resources on the CrossingGuard red-light enforcement market. The Company does not expect to receive material revenue related to Rail CrossingGuard in the future.
TrafficVision. TrafficVision is a product that uses video cameras to monitor traffic flow and to send traffic data to a central Traffic Operations Center. Replacing short-life, high-maintenance, road-embedded copper-loop technologies
from the 1950's, TrafficVision is a non-intrusive sensor system for traffic management. TrafficVision uses Nestor's proprietary high-speed image-processing technology to analyze video content to sense and monitor traffic on highways, roadways and intersections in real-time. TrafficVision recognizes and classifies multiple vehicles continuously so that surveillance and traffic management are based upon detailed, real-time information. TrafficVision is installed at 26 locations in Rhode Island and in the state's centralized Traffic Operations Center in Providence. During 2002, NTS realized $187,000 in TrafficVision related revenues and no such revenues in 2003. During 2002, the Company reduced its marketing and sales efforts in this product line to focus its resources on the CrossingGuard red-light enforcement market. The Company does not expect to receive material revenue related to TrafficVision in the future.
The following are the primary attributes of NTS products and services:
Accurate, real-time interpretation of traffic video images. NTS has applied Nestor's high-speed pattern-recognition technologies in real-time processing and video-image interpretation for traffic management, enforcement and safety. Prior industry attempts to provide video-based detection of traffic have not proven effective due to the difficulty of designing robust detection algorithms under a variety of illumination, visibility and traffic conditions, as well as the need to implement such algorithms on cost-effective computing platforms that provide real-time operation. Nestor's image-understanding technology is able to interpret video images accurately and respond in a real-time environment at affordable cost.
Vehicle trajectory analysis for real-time forecasting. As each frame in a video sequence is interpreted, the individual objects in the scene are identified and located. This information, passed from frame to frame, enables accurate tracing of vehicles' trajectories. Unlike competitive vision systems, which note changing images in a fixed and static area of the image (so-called virtual loops), NTS's proprietary vehicle-centric technology can use the trajectories to predict vehicle positions. In the CrossingGuard application, when a vehicle is about to run a red light, a signal can then be sent to the traffic controller to extend the all-red phase of the traffic signal so that cross traffic vehicles can be briefly delayed before they proceed into the intersection. Thus, intersections equipped with CrossingGuard have the potential to become smarter and safer.
Compatibility with industry standard platforms. NTS traffic monitoring solutions are built upon dominant industry-standard platforms: namely, Microsoft Windows operating systems, tools and communication components and general "WinTel" hardware specifications. This facilitates integration into a customer's existing computing environment, leverages PC economics to offer a compelling price/performance advantage and lowers product engineering development costs. Additionally, the traffic monitoring systems are designed to support the emerging NTCIP communications standards being mandated in the traffic industry. Further, roadside detector stations will be compatible with existing and new traffic controller hardware, such as the CALTRANS 2070 controller standard.
Description of other products and services:
In 2001, Nestor ceased direct product development, sales and support in the fields of fraud detection, financial risk management, and CRM. The Company does not expect to receive material revenue related to fraud detection, financial risk management, or CRM in the future. Through license agreements entered into with ACI on February 1, 2001, and with ReD on May 18, 2001, co-exclusive development, sales and support rights were granted to these resellers in fraud and risk management; and non-exclusive rights in the field of CRM were granted to ReD. In addition, all expenses associated with development, support and selling these products were transferred to these parties.
Nestor's PRISM(R) fraud detection solutions help financial institutions detect and prevent fraudulent payments, manage merchant risks and identify illicit account usage (money laundering). The fraud detection products are used by many of the world's largest financial institutions and represented approximately 31% and 87% of Nestor's 2002 and 2001 revenues, respectively. Effective July 1, 2002, the Company assigned its ACI royalty rights (Note 13) and no longer receives product royalties.
Nestor's ICR applications increase productivity in document image-processing applications. Royalties from the ICR business represented less than 1% of Nestor's 2003 and 2002 revenues.
Nestor's technology is licensed to IBM on a non-exclusive basis for incorporation into hardware products known as the ZISC family of computer chips. Royalties from the IBM business represented less than 1% of Nestor's 2003 and 2002 revenues.
Sales, Marketing and Methods of Distribution
The Company distributes and markets its intelligent traffic-management solution (ITS) software and services in North America through a direct sales organization. The Company distributed its other software solutions in North America and throughout the world through third- party licensing and distribution agreements.
Currently, the Company markets its products and services to municipalities, governmental traffic management departments, or their integrators through its Providence and San Diego based two-person direct sales force. Since the traffic products require technical assistance during the sales and installation processes, the Company also maintains an in-house staff of four program managers and eight engineers. The Company obtains product inquiries from product mailings, attendance at trade shows, trade press coverage and its Internet site. Most CrossingGuard contracts are obtained through competitive proposal processes in response to RFP's issued by municipalities.
The Company's Intelligent Character Recognition products are marketed by NCS. The Company's PRISM and eCLIPSE products are licensed through two distributors, Applied Communications, Inc. (ACI) and Retail Decisions, Inc., primarily to financial institutions. Effective with the sale of the future royalty revenues due from the ACI license to Churchill Lane Associates, LLC (CLA) on September 30, 2002, no future revenues related to the PRISM business are expected to be realized by the Company.
During 2002, ACI accounted for 31% of the Company's revenues. During 2002, Other Income of $2,812,000 was recorded as a result of the sale of the ACI royalty rights to CLA. No such revenues were recorded in 2003
Pattern-Recognition Technology
The Company's technology deals with the problem of pattern recognition within complex data. When presented with complex high-volume data, it can be valuable to identify target patterns of information often hidden in that data, whether patterns of fraudulent credit card use, customer buying behavior, handwritten characters, objects in a video stream, vehicles in a traffic flow, or others. Several methods currently exist to address the problem of processing information in order to recognize a pattern in the information. Included among these are "expert systems" of rules, statistical analysis, and neural networks. The Company's products may combine all of these methods to optimize pattern recognition capabilities.
Neural-networks simulate a virtual network of interconnected units, processing data in parallel, and communicating with each other at high speeds. A trained neural-network receives input and then outputs a response - either "unrecognized", "recognized", or "not sure". Exceeding the capability of if-then-else conditional rules, the power of the neural-networks is in their ability to accurately recognize patterns in multi-dimensional non-linear input, such as attempting to recognize characters from a scanned handwritten sample, which is ill-defined, affected by "noise", or blatantly unusual (i.e. overly large or small, or containing skewed characters). The Company, as the result of extensive research, has created a proprietary neural-network technology referred to as the Restricted Coulomb Energy Model(TM) (RCE), which has been granted five patents.
The Company has also been granted a sixth patent for a multi-unit system referred to as the Nestor Learning System(TM) (NLS), which is ideally suited for many real-world pattern recognition applications. The NLS has a patented hierarchical, multi-network system for better control and accuracy. The Company believes that the rapid model development and operational flexibility afforded by its technology provides a competitive advantage in the development of intelligent-decision software solutions.
RESEARCH AND DEVELOPMENT ACTIVITIES OF THE COMPANY
The Company continues to develop and improve its technologies and products and to develop new technologies and products. The Company intends to pursue new and enhanced technologies and products. The Company attempts to locate external resources to assist in funding the costs of developing new technologies or products, but may bear all of such costs internally.
The Company's research is almost entirely applied research intended to develop solutions to specific pattern-recognition problems. This research has resulted in various patents and patents pending relating to improvements to the Company's basic technology (see "Patents"). The Company has additional patent applications pending as of December 31, 2003, primarily in the area of traffic management, enforcement and safety.
The market for the Company's products may be impacted by changing technologies. The Company's success will depend upon its ability to maintain and enhance its current products and develop new products in a timely and cost-effective manner that meets changing market conditions. There can be no assurance that the Company will be able to develop and market on a timely basis, if at all, product enhancements or new products that respond to changing market conditions or that will be accepted by customers. Any failure by the Company to anticipate or to respond adequately to changing market conditions, or any significant delays in product development or introduction could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company expended $121,000, $1,604,000 and $1,641,000 in the years ended December 31, 2003, 2002 and 2001 respectively, in support of the various aspects of Company-sponsored research and development.
PATENTS
The Company has continually sought and obtained patent protection for its proprietary neural networks and other systems, which have as a principal feature rapid learning from a relatively small number of examples or the application of video techniques in traffic management applications. The Company's RCE neural network exhibits rapid learning and minimizes the internal connections needed for it's functioning. The Company believes that these capabilities make the Company's technology uniquely suited to applications that require field trainability or self-modification to adapt to new or changing patterns in the data. The Company's patents also cover multiple-neural-network systems, which enable the company to develop products that combine high accuracy with high processing speeds.
During 2003, the Company received two additional patents relative to the CrossingGuard product line. The first issued in June 2003 recognizes the Company's method of predicting and recording a red light violation with a video-based system including the use of violation probability scores. The second patent issued in November 2003 defines a system and method of detecting and filtering non-violations in a traffic light enforcement system employing a video camera to improve the effectiveness of the system.
During 2002, the Company received two additional patents relative to the CrossingGuard product line. The first patent recognizes the Company's invention of providing for a collision avoidance feature in a video-based red light enforcement system. The second patent recognizes the invention of a video-based red light enforcement system integrating a client management system integrated with a court scheduling system for ticket processing and issuance.
The Company owns 10 United States patents and 5 foreign patents issued in four countries, Australia and Europe. The foreign patents correspond to one or more of the United States patents. The United States patents expire at various times from 2006 to 2021.
COMPETITION
The Company believes that CrossingGuard is more technologically advanced than most competing systems for traffic safety enforcement. Its competition generally consists of "wet film" or digital still image red light camera systems. These systems generally rely on in-ground sensor loops and wet film, or on digital
still cameras that record only a few frames of evidence regarding a violation. For wet film systems, there is the added burden of retrieving, replacing, developing, and scanning the film. By the end of 2003, most competitors have developed digital still systems and do not promote wet film applications. The Company is aware of two competitors that have included video cameras in their systems. The Company has initiated patent infringement lawsuits against these competitors on the basis of its February 13, 2001 patent entitled "Integrated Traffic light Violation Citation Generation and Court Date Scheduling System". See "Item 3 -- Legal Proceedings." There can be no assurance that the Company will be successful in defending this patent and limiting the use of video by competitors in the U.S. red light enforcement market.
CrossingGuard vehicle detection cameras, on the other hand, are installed above the ground, on roadside poles or if needed, mast arms. (This helps avoid some of the logistical problems associated with installing in-ground sensors at an intersection.) In case of a dispute, unlike non-video systems, the violation video sequence has the ability to provide an instant replay of the event. Its digital video evidence consists of both front and rear vehicle images and is viewed by the police who then issue (or give authorization to issue) a citation. This ensures fairness so that violations may not be issued out of context (e.g., if the violation occurred to make way for an emergency vehicle, as part of a funeral procession, or to avoid a crash). This perception of fairness makes the Company's video evidence attractive to city councils, law enforcement officials, courts, and the general public.
NTS's largest competitors in the intersection market are Affiliated Computer Services, Inc. (ACS), which has the greatest number of red-light camera systems installed, and Redflex Traffic Systems, Inc. (Redflex). Among others are Laser Craft, Mulvihill ICS, Peek Traffic, Poltech, Traffipax, Transol, and Transcore. Although these companies use buried loops, still or digital cameras and/or wet film systems, some may pose a competitive threat due to their size, market share, legacy customer relationships, enhanced driver image, additional products offered, and/or citation-processing experience.
NTS's TrafficVision and Rail products face competition primarily from traffic-management-systems companies such as ISS, Econolite, Traficon, Iteris, Peek Traffic, Odetics, Computer Recognition Systems, Siemens, Sumitomo, and Rockwell International. Management believes that the platforms on which these products operate do not provide the image processing capabilities possessed by TrafficVision and Rail CrossingGuard. However, the Company is not currently investing substantial finances in the development, marketing or sales of these product lines.
Most of the Company's competitors in the ITS market have significantly greater financial, marketing and other resources than the Company. As a result, they may be able to respond more quickly to new or emerging technologies or to devote greater resources to the development, promotion and sale of their products than the Company. Competitive pressures faced by the Company may materially adversely affect its business, financial condition and results of operations.
CONTRACTS WITH GOVERNMENTAL ENTITIES
NTS's CrossingGuard agreements are generally service contracts with states or municipalities that in most circumstances may be cancelled by the customer for various reasons including non-appropriation of annual program funding. As these contracts are generally self-funded from ticket fees collected from red-light violators and some contracts contain termination fee provisions, NTS does not expect this to be a significant risk in the future. NTS's Rail CrossingGuard and TrafficVision contracts were generally fixed-fee deliverable contracts and termination rights were generally limited to non-performance conditions. NTS retains all patent and other proprietary rights from products developed and delivered under government-supported contracts.
EMPLOYEES
As of December 31, 2003, the Company had 49 full-time employees, including 11 in software engineering and product development, 11 in processing and system support, 17 in program management and field services, 3 in sales and marketing and seven in management, finance and office support. All of these employees are located in the United States. None of the Company's employees are represented by a labor union. The Company has experienced no work stoppages and believes its employee relationships are generally good.
The Company's success depends to a significant degree upon the continued employment of the Company's key personnel. Accordingly, the loss of any key personnel could have a materially adverse effect on the Company's business, financial condition and results of operations. The Company believes its future success will depend upon its ability to attract and retain industry-skilled managerial, engineering, software development and sales personnel, for whom the competition has been intense. In the past, the Company has experienced difficulty in recruiting a sufficient number of qualified engineering and sales people. In addition, competitors may attempt to recruit the Company's key employees. There can be no assurance that the Company will be successful in attracting, assimilating and retaining such qualified personnel, and the failure to attract, assimilate and retain key personnel could have a materially adverse effect on the Company's business, financial condition and results of operations.
LICENSING, JOINT VENTURE AND DEVELOPMENT AGREEMENTS
The Company entered into license agreements and research and development contracts in order to obtain greater market penetration and additional funding of the development of its technology in specific fields of use.
Applied Communications, Inc. (ACI) On February 1, 2001, the Company entered into a new non-exclusive license agreement with Applied Communications, Inc., a subsidiary of Transaction Systems Architects, Inc. Pursuant to the license agreement, ACI has been granted the right to integrate and distribute all of the Company's PRISM and fraud detection products throughout ACI's worldwide sales and support network. ACI paid $1.1 million to the Company in four equal installments over the four months following February 1, 2001, and was required to make guaranteed minimum royalty payments during the first year in an amount of approximately $500,000. The license requires the payment of a 15% royalty starting on February 1, 2002, but no further guaranteed minimum royalty payments will be required. This agreement replaces the license agreement signed with ACI on April 18, 1997. Additionally, ACI hired twelve of the Company's engineering, modeling, and customer support employees and assumes responsibility for product enhancements, installation, modeling, and support for ACI licensees. The Company sold the royalty rights to CLA on July 1, 2002. The Company does not expect to receive future revenues from this license.
Retail Decisions, Inc. (ReD) On May 18, 2001, Nestor entered into a license agreement with Retail Decisions, Inc. in which Nestor granted to ReD: (i) an exclusive (other than ACI), perpetual, fully-paid, worldwide license in the field of use of fraud and money laundering detection and risk management in certain defined industries; and (ii) a non-exclusive, perpetual, fully-paid, worldwide license solely for use in the field of use of customer relationship management in certain defined industries. Additionally, Nestor transferred to ReD certain assets that were supportive of the technology licensed thereunder. The assets transferred to ReD by Nestor include all of the right, title and interest of Nestor in certain equipment, license agreements (excluding ACI) and trademark rights. To support its newly acquired license, ReD hired 13 of Nestor's employees. ReD paid $1,800,000 to Nestor under the license agreement, and Nestor agreed, for certain marketing and transition services, to pay to ReD: (i) $500,000 which was paid on July 2, 2001; (ii) $250,000 which was paid on October 1, 2001; and (iii) $218,000 which was paid on December 31, 2001. The Company recorded $832,000 as net license revenue in the second quarter in connection with this agreement. No ongoing revenues are expected to be realized from ReD.
National Computer Systems, Inc. (NCS) On June 11, 1996, the Company entered into an exclusive Licensing Agreement and an Asset Purchase Agreement with NCS transferring the development, production, and marketing rights of the Company's Intelligent Character Recognition (ICR) products to NCS. In June 1998, NCS did not meet its minimum royalty for the license year and forfeited exclusive rights. NCS continues to market the ICR products on a non-exclusive basis. Nestor receives approximately $25,000 in minimum royalties per year under this license.
ITEM 2.
ITEM 2. Properties. ----------
In 2000, NTS entered into a five-year lease for offices providing 9,600 square feet for approximately $10,800 per month located at 400 Massasoit Avenue, East Providence, Rhode Island 02914. NTS also maintains a local field office at 737 Pearl Street, La Jolla, CA 92037 on a month-to-month lease dated August 2002, and pays approximately $1,500 per month. NTS also maintains a local field office at 330 East Orangethorpe Ave. in Placentia, CA on a twenty-four month lease dated March 2004, and pays approximately $1,400 per month. The Company believes
these facilities are adequate to meet its current needs and will require additional space as new installations increase processing and support hiring needs.
In April 2001, NTS entered into a forty-six month sublease for its California operations at 10145 Pacific Heights Blvd., San Diego, CA 92121 providing for approximately 5,700 square feet for $12,050 per month. As a result of the Company's reorganization in early 2002, NTS could no longer use the amount of space leased. Due to past due lease payments, the landlord terminated the lease and notified NTS to leave the premises, which NTS did in early August 2002. The Company is carrying a reorganization reserve related to projected costs of settling this lease obligation, and reached a settlement with the landlord under terms within the reserve established.
ITEM 3.
ITEM 3. Legal Proceedings. -----------------
On November 6, 2003, the Company filed a complaint in the United States District Court for Rhode Island against Redflex Traffic Systems, Inc., alleging that Redflex's automated red light enforcement systems infringe the Company's patent. Redflex denies this allegation. On November 25, 2003, the Company filed a complaint in the United States District Court for the District of Central California against Transol USA, Inc., alleging that Transol's automated red light enforcement systems infringe the Company's patent. Transol has counterclaimed that Nestor's patent is invalid and that Transol does not infringe on it. Nestor was denied a preliminary injunction in the Transol litigation. The Company cannot give assurance that we will be successful in either action.
During April 2003, the former president of NTS resigned as a member of the board of directors of the Company. The president's employment with the Company and NTS terminated. The president filed a complaint against the Company and NTS in the Providence Superior Court seeking severance benefits, including twelve months salary of $180,000, upon termination. See Form 8-K dated April 9, 2003 for further information. The parties reached a mutually agreeable settlement on December 31, 2003, the terms of which are confidential. All claims have been dismissed.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders. ----------------------------------------------------
No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2003.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Stock and Related Stockholder Matters. --------------------------------------------------------------------
The Company's common stock was first offered to the public in December 1983 and is traded on the Nasdaq OTC Bulletin Board under the symbol "NESO." The prices below have been adjusted to reflect the 1 for 10 reverse stock split during the second quarter of 2003. Before the stock split, the Company's common stock traded under the symbol "NEST."
Low High --- ---- Year Ended December 31, 2003 - ---------------------------- 1st Quarter $ .30 $ 1.90
2nd Quarter $ .80 $ 2.60
3rd Quarter $ 1.30 $ 2.05
4th Quarter $ 1.60 $ 4.90
Year Ended December 31, 2002 - ---------------------------- 1st Quarter $ 4.50 $10.30
2nd Quarter $ 1.80 $ 5.80
3rd Quarter $ .80 $ 2.80
4th Quarter $ .20 $ 1.00
Holders of Common Stock
At March 18, 2004, the number of holders of record of the issued and outstanding common stock of the Company was 483, which includes brokers who hold shares for approximately 1,555 beneficial holders.
Dividend Policy
The Company has not paid any cash dividends with respect to its common stock since formation and does not expect to pay cash dividends in the foreseeable future.
Securities Authorized for Issuance Under Equity Compensation Plans
Incorporated by reference from the Company's definitive proxy or information statement to be filed with the Securities and Exchange Commission not later than 120 days following the end of the Company's fiscal year.
Recent Sales of Unregistered Securities
On December 31, 2003, the Company exercised its option to satisfy its obligations to Silver Star Partners I, LLC under a $2,000,000 principal amount convertible note by issuing 676,384 shares of the Company's common stock at a conversion price of $3.00 per share.
The Company issued 2,843,000 shares of its common stock in January 2004 in a series of private placements made to accredited investors, at an aggregate price of $8,529,000. In connection with those private placements, the Company paid an aggregate sales commission of $682,320. The shares of common stock were issued without registration under the Securities Act in reliance on the exemption provided by Section 4(2) of the Securities Act.
On January 14, 2004, the Company issued to Laurus Master Fund Ltd. ("Laurus") a Convertible Note (the "Note") in the principal amount of $1,500,000 that bears interest at the prime rate plus 1.25% (subject to a floor of 5.25% per year) and
matures on January 14, 2006. The Note may be repaid at the Company's option, in cash or, subject to certain limitations, through the issuance of shares of common stock. The Company will have an option to pay the monthly amortized amount in shares at the fixed conversion price of $3.50 per share if the shares are registered with the Securities and Exchange Commission ("SEC") for public resale and the then current market price is 120% above the fixed conversion price. The Note includes a right of conversion in favor of Laurus. If Laurus exercises its conversion right at any time or from time to time at or prior to maturity, the Note will be convertible into shares of the Company's common stock at a fixed conversion price, subject to adjustments for stock splits, combinations and dividends and for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the Company's agreement with Laurus). In conjunction with this transaction, Sage Investments, Inc. will be paid a fee of $60,000. The Company has agreed to file a registration statement with the SEC to register the public resale by Laurus of the common stock to be issued upon conversion of the Note. The Note was issued without registration under the Securities Act in reliance on the exemption provided by Section 4(2) of the Securities Act.
ITEM 6.
ITEM 6. Selected Financial Data. -----------------------
The following data includes the accounts of Nestor, Inc. for all periods presented and NTS for the period September 13, 2001 through December 31, 2001 and the years 2003 and 2002. (From January 1, 1999 through September 12, 2001, the Company's investment in NTS was recorded on the equity method.)
ITEM 7.
ITEM 7. Management's Discussion and Analysis ------------------------------------
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The following discussion includes "forward-looking statements" within the meaning of Section 21E of the Securities and Exchange Act of 1934, and is subject to the safe harbor created by that section. Forward-looking statements give our current expectations or forecasts of future events. All statements, other than statements of historical facts, included or incorporated in this report regarding our strategy, future operations, financial position, future revenues, projected costs, prospects, plans and objectives of management are forward-looking statements. The words "anticipates," "believes," "estimates," "expects," "intends," "may," "plans," "projects," "will," "would" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Factors that could cause results to differ materially from those projected in the forward-looking statements are set forth in this section and in Exhibit 99.1. The following discussion should also be read in conjunction with the Consolidated Financial Statements and accompanying Notes thereto.
Readers are cautioned not to place undue reliance on these prospective statements, which speak only as of the date of this report. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's other reports filed with the Securities and Exchange Commission.
EXECUTIVE SUMMARY
The Company considers following areas to be of highest importance in 2003 and 2004: o During 2003 through January 2004, the Company raised $15.7 million in financing. This was critical to the continuance of operations in early 2003 and the Company's ability to support construction on its 2003 customer contract backlog. Expensive debt obligations were eliminated in January 2004 and the Company has both cash and available financing to support anticipated 2004 business expansion. o The Company has completed the transition from several lines of business including financial services/PRISM, Rail and TrafficVision which generated the majority of revenue in 2001 and 2002, to intelligent traffic management products and services, primarily red-light enforcement services and products, as the on-going operating focus of the Company. The Company's leading product is its CrossingGuard video-based red light enforcement system. o Revenues are not yet sufficient to support operating expenses. The Company needs to install additional CrossingGuard approaches and is currently retrofitting some operating approaches to improve performance. Over the past year, the Company more than doubled the number of operating red-light enforcement approaches to 88 at December 31, 2003. Additional approaches to contribute to 2004 revenue are expected to come from existing customer contracts which have not been fully built out, the recently announced Delaware Department of Transportation statewide contract and new customers to be signed. o Over the past years, the Company has devoted substantial resources to the development of its patented technology and it will vigorously contest infringement thereon. In November 2003, the Company filed complaints in United States District Courts against two of its competitors, alleging that their automated red light enforcement systems infringe upon the Company's patent. Further details are discussed in the Liquidity and Capital Resources and Results of Operations sections below.
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Working Capital
The Company had cash and short-term investments of approximately $5,410,000 at December 31, 2003 as compared with approximately $309,000 at December 31, 2002. At December 31, 2003, the Company had working capital of $3,294,000, as compared with a working capital deficit of $1,572,000 at December 31, 2002. The increase in cash and working capital in 2003 substantially relates to private placement common stock sold at year-end.
In January 2004, the Company received $3.4 million in additional proceeds on the remaining private placement offering, $2.2 million of which was used to settle the remaining lease obligation to Electronic Data Systems Corporation (EDS). The EDS settlement resulted in a gain on early extinguishment of debt of $681,000 and eliminated the 12% interest obligation.
Also in January 2004, the Company satisfied its obligations on a July 2003 $2 million Laurus Master Fund, Ltd. (Laurus) convertible note by issuing 492,904 shares of Nestor common stock and repaying the note balance, accrued interest and prepayment penalty. On the same date, Laurus entered into a new $1.5 million note ("second Laurus note"). While Nestor received $98,000 as a net result of these transactions, the more beneficial change was increasing the fixed conversion price, as defined in the notes, from $1.55 per share in the first note to $3.50 in the new note.
The Company had a net worth of $9,662,000 at December 31, 2003, as compared with a net worth of $3,865,000 at December 31, 2002. The increase in net worth resulted primarily from the equity financing activities vigorously pursued during the year, resulting in over $10 million being raised, offset by the consolidated net loss. Silver Star Partners I, LLC (SSP) invested $4.2 million through April 2003 and, on December 31, 2003, the Company converted an October 2003 $2 million note payable to SSP into common stock. Also in December 2003, the Company raised $4.4 million from a private placement offering. See Note 9 for additional information.
Future Commitments
During 2003, the Company acquired additional property and leased equipment (primarily computers and related equipment) at a cost of $86,000, and invested $2,341,000 in capitalized systems. At December 31, 2003, Nestor recorded its investments in computers and related equipment (net of depreciation) at $385,000, and in capitalized systems (net of depreciation) at $3,515,000. Management expects that NTS will make future commitments for the purchase of additional computers and related computing equipment, for furniture and fixtures, for delivery of capitalized systems, for consulting and for promotional and marketing expenses.
As discussed above, the Laurus note payable and the EDS lease payable presented on the December 31, 2003 balance sheet were satisfied in January 2004. The second Laurus note calls for principal repayments to commence May 2004 with $375,000 due in 2004, $1,012,500 due in 2005 and $112,500 due in January 2006 before maturity.
The Company does not generally grant payment terms to customers in excess of 90 days.
After satisfying the initial Laurus note payable and the EDS lease payable in January 2004, the Company's future contractual obligations (assuming Laurus does not exercise its conversion rights) and other commitments are as follows:
Contractual Obligations and Commercial Commitments:
Payment Due Date ---------------------------------------------------- Total < 1 Year 1-3 Years 3-5 Years Thereafter ----- -------- --------- --------- ----------
Second Laurus note $1,500,000 $375,000 $1,125,000 $ --- $ --- payable
Operating leases $ 221,000 $137,000 $ 84,000 $ --- $ ---
Inflation
Management believes that the rate of inflation in recent years has not had a material effect on the Company's operations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Nestor's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions (see Note 2 to the Consolidated Financial Statements). The Company believes that of its significant accounting policies (see Note 2 to the Consolidated Financial Statements), the following may involve a higher degree of judgment and complexity.
Revenue Recognition
The Company's CrossingGuard product generates lease and service fee revenue generally tied to the number of citations issued to red-light violators. Under the terms of several current contracts, the Company cannot bill the municipality until the court has collected the citation fine. On these contracts, management estimates the percentage of citations that are expected to be collectible and recognizes revenue accordingly. To the extent these estimates are not accurate, the Company's operating results may be significantly and negatively affected. This will have less impact on the Company going forward as new contracts do not have this provision and are trending towards fixed fee terms.
In arrangements, some of which include software, or where software services are deemed essential, revenue is recognized using contract accounting. This methodology involves a percentage-of-completion approach, based on progress-to-completion measures on estimated total costs. If the Company does not accurately estimate these total costs, or the projects are not properly managed to planned periods and expectations, then future margins may be significantly and negatively affected or losses on existing contracts may need to be recognized.
Long Term Asset Impairment
In assessing the recoverability of the Company's long term assets, management must make assumptions regarding estimated future cash flows and other factors to determine the fair value. If these estimates change in the future, the Company may be required to record impairment charges that were not previously recorded pursuant to Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets".
RESULTS OF OPERATIONS
During 2003, the Company completed the transition from several lines of business including financial services/PRISM, Rail and TrafficVision which generated the majority of revenue in 2001 and 2002, to red-light enforcement services and products as the on-going operating focus of the Company. The Company's leading product is its CrossingGuard video-based red light enforcement system and services, and future growth will be tied to the increase in the number of CrossingGuard approaches installed and operational. In 2002 and 2001, the Company reorganized by (i) eliminating direct investment in its financial services/Risk Management products, transferring all contracts through license and/or assignment to other parties and (ii) through a further operations reduction, restructured the Company to focus primarily on its CrossingGuard product.
ANALYSIS OF THE THREE-MONTH PERIODS ENDED DECEMBER 31, 2003 AND 2002
In the quarter ended December 31, 2003, the Company realized a 236% ($788,000) increase in revenues and 142% ($1,379,000) increase in operating expenses compared to the prior year, same quarter. After consideration of $340,000 of increased other expenses in 2003, the Company reported a net loss of $1,592,000 compared to $662,000 in the prior year fourth quarter. The revenue and expense increases relate primarily to having more than double the number of installed operational approaches in the current year fourth quarter compared to the prior year fourth quarter. Additionally, operating expenses include $225,000 relating to financing activities and $130,000 of patent lawsuit expenses in the current year quarter. Other expense in the fourth quarter of 2003 included the write off of the unamortized discount on the first Laurus note and EDS interest expense, both of which did not occur in the prior year fourth quarter.
Revenues - --------
The Company's revenues arose from CrossingGuard lease and service fees. During the quarter ended December 31, 2003, revenues increased $788,000 to $1,122,000 from $334,000 in the prior year fourth quarter. The Company had 48 additional installed approaches in the current year fourth quarter compared to the prior year fourth quarter. At December 31, 2003, the Company had 88 installed operational approaches.
Operating Expenses - ------------------
Total operating expenses amounted to $2,353,000 in the quarter ended December 31, 2003, an increase of $1,379,000 as compared to total operating costs of $974,000 in the prior year same quarter.
Cost of Goods Sold
Cost of goods sold (CGS) totaled $940,000 in the fourth quarter of 2003 as compared to $97,000 in 2002. The 2003 CGS relates to amortization, maintenance and processing costs to support 88 approaches compared to only 40 in the fourth quarter of 2002. The 2003 quarter also includes a $417,000 net reclassification of all 2003 citation processing costs from engineering and operations as previously presented to CGS. Citation processing costs were not material in the 2002 quarter and were not reclassified to conform to the 2003 presentation. Additionally, the fourth quarter of 2002 included a $102,000 reversal of EDS processing costs which was not repeated in 2003.
Engineering and Operations
Costs related to engineering and operations totaled $419,000 in the fourth quarter of 2003, as compared with $596,000 in 2002. These costs include the salaries of field and office personnel as well as operating expenses related to product design, delivery, configuration, maintenance and service. Increases in headcount, travel and supplies generated $206,000 of additional costs in the 2003 quarter but were offset by a $417,000 net reclassification of all 2003 citation processing costs to CGS in fourth quarter 2003. Citation processing costs were not material to 2002 engineering and operations and were not reclassified to conform to the 2003 presentation.
Research and Development
Research and development expenses totaled $29,000 in the quarter ended December 31, 2003 as compared with $31,000 in the previous year's quarter. The Company continues its R&D activities, as deemed necessary.
Selling and Marketing
Selling and marketing costs were $87,000 in the quarter ended December 31, 2003, and $89,000 in the previous year's quarter. Sales and marketing efforts had been limited recently due to cash constraints but are expected to increase in 2004.
General and Administrative
General and administrative expenses totaled $876,000 in the fourth quarter of 2003, as compared with $160,000 in the previous year's quarter. These costs were unusually high in the current year quarter due to (i) $225,000 of Laurus and Silver Star deferred financing fees being expensed in connection with note redemptions/conversions, (ii) $130,000 of patent lawsuit defense expenses and (iii) $84,000 of bad debt expense. Additionally, the fourth quarter of 2002 included a reversal of $113,000 of Wand Partners, Inc. fees in connection with a Termination and Release Agreement.
Other Expense
For the fourth quarter 2003, net other expense was $362,000 as compared with net other expense of $22,000 in the quarter-earlier period. In 2003, other expense was primarily interest of (i) $169,000 relative to the write off of the
unamortized discount on the first Laurus note and $59,000 of other Laurus interest, (ii) $89,000 to EDS. Both periods included warrant amortization expense of $26,000.
Net Loss - --------
During the fourth quarter 2003, the Company experienced a loss of $1,592,000, as compared with a loss of $662,000 in the previous year's quarter. For the quarter ended December 31, 2003, loss per share available for common stock was $0.11 per share, as compared with a loss per share of $0.13 in the corresponding period of the prior year. The weighted average shares outstanding were 13,987,905 for the quarter ended December 31, 2003 and 5,047,611 for the quarter ended December 31, 2002.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2003 AND 2002
For the year ended December 31, 2003, the Company experienced a 28% ($584,000) increase in revenues compared to the prior calendar year. Operating expenses decreased 60% ($10,282,000) in 2003. After consideration of the $2,812,000 gain on royalty assignment in 2002 and $311,000 of increased other expenses in 2003, the Company reported a net loss of $4,890,000 in 2003 compared to a loss of $12,634,000 in the prior year. Many significant changes occurred during these two years as more fully described below.
Revenues - --------
The Company's revenues arose from royalties and product sales, lease and service fees as discussed separately below. During the year ended December 31, 2003, revenues increased $584,000 to $2,706,000 from $2,122,000 in the prior calendar year. CrossingGuard accounted for 40% of 2002 revenues and substantially all 2003 revenues.
Ongoing revenues from the risk management product line continued under the ACI distributor agreement until July 2002 when it was assigned to CLA.
Product Royalties
Product royalties totaled $29,000 in 2003, as compared with $664,000 in 2002. The Company continued to receive royalties from ACI until July 1, 2002 when these royalty rights were assigned to Churchill Lane Associates, LLC. Residual royalty streams from two customers account for 2003 royalty revenues.
Product Sales, Lease and Service Fees
Product sales, lease and service fee revenues from the traffic business totaled $2,677,000 in 2003, as compared with $1,457,000 in 2002, due primarily to the installed base of approaches more than doubling from December 31, 2002 to December 31, 2003. Revenue in 2002 was comprised of $844,000 in CrossingGuard video-based traffic enforcement, $387,000 in Rail business and $187,000 in TrafficVision business, whereas 2003 revenue was substantially all CrossingGuard.
CrossingGuard construction started slowly in Q1 '03 but by the end of Q2, there were 20 additional approaches installed, followed by 12 and 16 more in Q3 and Q4, respectively, to total 88 live approaches by the end of 2003. Construction is not expected to continue at this pace in 2004 unless new contracts are signed. During March 2004, the Company installed three new approaches under its contract with the Delaware Department of Transportation. The Company is currently retrofitting some operating approaches to improve performance and is working with its customers to complete build outs of remaining approaches committed under existing contracts.
Operating Expenses - ------------------
Total operating expenses amounted to $6,967,000 in the year ended December 31, 2003, a decrease of $10,282,000 over total operating costs of $17,249,000 in the prior year. The 2002 expenses include $743,000 in restructuring costs and $9,294,000 of impairment charges. Excluding restructuring and impairment
charges, operating expenses in 2002 were $7,212,000. The most significant changes in 2003 were $414,000 of increased amortization on live approaches, $240,000 of increased financing fees and $130,000 of patent lawsuit defense expenses; offset by $538,000 of CGS expense pertaining to discontinued product lines (Rail, TrafficVision) and pilot programs.
Costs of Goods Sold
Cost of goods sold totaled $1,791,000 in 2003 as compared to $1,476,000 in the prior year. CGS includes amortization, maintenance and processing costs related to revenues recorded in the respective periods. Fiscal year 2002 includes $289,000 (Rail), $138,000 (TrafficVision) and $111,000 (pilot program) CGS which did not recur in 2003 but were offset by a $414,000 current year increase in system amortization due to the increased number of installed approaches and a $417,000 net reclassification of 2003 citation processing costs from engineering and operations as previously presented to CGS. Additionally, 2002 included a $102,000 reversal of EDS processing costs which was not repeated in 2003.
Engineering and Operations
Costs related to engineering and operations totaled $2,578,000 in 2003, as compared with $2,070,000 in 2002. These costs include the salaries of field and office personnel as well as operating expenses related to product design, delivery, configuration, maintenance and service. The increase in these costs reflects the addition of NTS expenses both internally and field-based, to support the growing installed customer base. Staff realignments from R & D were necessary to assist in engineering efforts. Also, $417,000 of net citation processing costs were reclassified to CGS in fourth quarter 2003. Citation processing costs were not material to 2002 engineering and operations and were not reclassified to conform to the 2003 presentation.
Research and Development
Research and development expenses totaled $121,000 in the year ended December 31, 2003 as compared with $1,604,000 in the prior year. R & D efforts had been significant to roll out the Rail and CrossingGuard products, which occurred in 2002. In March 2002, management took steps to reduce the heavy use of third party contractors to support development projects (consulting costs decreased by $183,000 in 2003) and also made staff realignments to assist engineering with the increased customer base. Although the June 2002 restructuring further contributed to a $361,000 reduction in salaries, talent and capacity remain for research and development, as management deems appropriate.
Selling and Marketing
Selling and marketing costs decreased $253,000 to $355,000 in the year ended December 31, 2003, from $608,000 in the prior year. The decrease in selling costs in the year reflects, primarily, the re-focus of strategy to one product line, which lowered salaries and collateral costs. Sales and marketing efforts had been limited recently due to cash constraints but are expected to increase in 2004.
General and Administrative
General and administrative expenses totaled $2,121,000 in 2003, as compared with $1,453,000 in the previous year. The increase is the net result of (i) $240,000 of financing fees in conjunction with the July 2003 Laurus and the October 2003 Silver Star notes, (ii) $130,000 of legal expenses on patent lawsuit defense, (iii) $102,000 in general legal expenses, (iv) $84,000 of bad debt expense and (v) the 2002 reversal of $113,000 of Wand Partners, Inc. fees in conjunction with a Termination and Release Agreement.
Restructuring Costs
In June 2002, the Company underwent a significant restructuring involving management changes and cost control to lower personnel and facilities expenses as the Company refocused its efforts solely on its red-light video enforcement contracts for CrossingGuard installations. The Company terminated 19 full-time employees, affecting all departments, and offices were consolidated into smaller facilities. During the quarter ended June 30, 2002, the Company recorded
restructuring costs of $743,000 primarily comprised of $332,000 in employee severance agreements and estimated lease obligations associated with closing its Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in connection with the Providence office lease and in 2003 in connection with the San Diego office lease.
Capitalized Systems Costs Impairment
During the quarter ended June 30, 2002, the Company determined that potential citation revenues from certain CrossingGuard installations in two cities would not exceed the cost of the underlying carrying value of the capitalized systems. These contracts were signed in the early stages of CrossingGuard development and the site selection procedures and contract terms have since been improved. In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company wrote off capitalized systems costs of $794,000 and recorded a corresponding impairment charge in operating expenses. Ongoing revenues from these installations are expected to offset future costs of system operations.
Goodwill Impairment Loss
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, the Company will test goodwill for impairment on an annual basis, or whenever indicators of impairment are identified. The Company completed the transitional impairment test of goodwill during the quarter ended June 30, 2002 and concluded that no impairment existed on January 1, 2002, when the standard was adopted. Management considers the Company's quoted stock price to be the best indicator of fair value for purposes of performing these analyses.
Based on the decline of the Company's stock price during the second and third quarters of 2002, however, the fair value was recomputed using the quoted quarter-end stock prices. Such computations resulted in goodwill impairment charges of $3,000,000 and $5,500,000 recorded as operating expenses during the respective 2002 quarters. The Company continues to monitor goodwill for potential impairment.
Gain on Royalty Assignment
On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU") with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the Company's rights to royalty income under the license agreement between the Company and ACI ("ACI License"). CLA is owned and controlled by Alan M. Wiener, Alvin J. Siteman and Robert M. Carroll, former directors and shareholders of the Company. The MOU also provided a schedule for advances by CLA to provide interim financing to the Company during the period prior to the closing. Upon closing on September 30, 2002, CLA paid the Company $3.1 million in cash (less advances) for the irrevocable assignment of its royalty rights under the ACI License from July 1, 2002 and in perpetuity. No obligations or other rights of the Company were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI deferred income and $60,000 in related professional fees, the Company recorded a $2,812,000 gain on this royalty assignment on September 30, 2002. The elimination of ACI unbilled contract revenue and deferred income were recorded as non-cash reductions.
Contract Termination Reserve
A significant customer contract in the Rail line of business may be terminated by mutual agreement prior to its completion as a result of the Company's decision to focus its resources on CrossingGuard systems and services. The Company accrued $125,000 of estimated contract termination fees in June 2003.
Other Expense - -------------
For 2003, net other expense was $504,000; as compared with net other expense of $319,000 in the year-earlier period. In 2003, other expense included interest expense of $470,000 as compared to $217,000 in 2002, 2003 also included a $64,000 favorable settlement with a vendor and both years included $106,000 of amortization expense related to the assigned value of warrants outstanding and being amortized over their remaining life. Interest expense was high in 2003 due to the $169,000 write off of the unamortized discount on the first Laurus note and $59,000 of other Laurus interest.
Net Loss - --------
During 2003, the Company experienced a loss of $4,890,000, as compared with a loss of $12,634,000 in the prior year. For the year ended December 31, 2003, loss per share was $0.38 per share, as compared with a loss per share of $2.50 in the corresponding period of the prior fiscal year. For the year ended December 31, 2003, there was outstanding a weighted average of 12,964,498 shares, as compared to 5,047,611 shares in the year-earlier period.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2002 AND 2001
In the year ended December 31, 2002, the Company experienced a 40% decrease in revenues compared to the prior calendar year. Operating expenses increased 258% in 2002 resulting in a loss of $12,634,000 as compared to a loss of $1,565,000 in the prior year.
Revenues - --------
The Company's revenues arose from royalties and product sales, lease and service fees as discussed separately below. During the year ended December 31, 2002, revenues decreased $1,399,000 to $2,122,000 from $3,521,000 in the prior calendar year. The Company granted source-code distribution rights to two companies in 2001 for up-front source-code license fees and, from ACI, ongoing royalties of equal to 15% of future revenues realized from the licensed software. Beginning in the fourth quarter of 2001, the Company's revenues were generated primarily from sales, support, and services provided regarding its intelligent traffic management product line. Ongoing revenues from the risk management product line continued under the ACI agreement until July 2002 when it was assigned to CLA.
Product Royalties
Product royalty revenues totaled $664,000 in 2002, as compared with $2,997,000 in 2001. The Company realized net ReD license revenues of $832,000 in the second quarter of 2001, and $1,104,000 from the ACI license in the first quarter of 2001. The Company continued to receive royalties from ACI until July 1, 2002 when these royalty rights were assigned to CLA
Product Sales, Lease and Service Fees
Product sales, lease and service fee revenues from the traffic business totaled $1,457,000 in 2002, as compared with $524,000 in 2001, which included only post-merger revenues.
Operating Expenses - ------------------
Total operating expenses amounted to $17,249,000 in the year ended December 31, 2002, an increase of $12,431,000 over total operating costs of $4,818,000 in the prior year. The 2001 operating expenses reflect risk management operations that were transferred to ACI and ReD in 2001 whereas the 2002 expenses reflect current traffic management operations, which include $743,000 in restructuring costs and $9,294,000 of impairment charges. Excluding restructuring and impairment charges, operating expenses in 2002 were $7,212,000.
Costs of Goods Sold
Cost of goods sold totaled $1,476,000 in 2002 as compared to $692,000 in the prior year, which included only post September 12, 2001 expenses. CGS includes third party goods and services related to revenues recorded in the respective periods and is high in proportion to revenues realized due to (i) rail projects completed in the first quarter of 2002 that carried higher equipment and construction costs than prior experience as NTS acted as prime contractor on these construction related projects, and (ii) our back-office processing agreement with EDS required a monthly minimum fee that was proportionately high in relation to actual ticket volumes generated. In July 2002 a letter agreement was reached and finalized in January 2003 to eliminate the monthly minimum fee, reducing the per-ticket processing fees charged retroactive to January 1, 2002. In December 2002, NTS recorded a $102,000 reduction in CGS in connection with the modified terms. NTS performs these services internally as of March 31, 2003. Additionally, in the quarter ended September 30, 2002, NTS reclassified customer-related telecommunications expenses from various operating expenses to CGS, effective October 1, 2001.
Engineering Services
Costs related to engineering services totaled $2,070,000 in 2002, as compared with $509,000 in 2001. The increase reflects the addition of NTS engineering expenses effective with the merger completed September 12, 2001.
Research and Development
Research and development expenses totaled $1,604,000 in the year ended December 31, 2002 as compared with $1,623,000 in the prior year. The increase in such costs reflects the net increased investment in the NTS products included in the consolidated expenses after the merger completed on September 12, 2001, offset by the transfer of PRISM research and development activity to ACI and ReD during early 2001.
Selling and Marketing
Selling and marketing costs decreased $171,000 to $608,000 in the year ended December 31, 2002, from $779,000 in the prior year. The decrease in selling costs in the year reflects, primarily, the transfer of sales and marketing activity for the PRISM product to ACI and ReD during early 2001.
General and Administrative
General and administrative expenses totaled $1,453,000 in 2002, as compared with $1,214,000 in the previous year. The increase is the net result of a full year of combined Nestor and NTS expense in 2002, offset in part by the 2002 reversal of $113,000 of Wand Partners, Inc. fees in connection with a Termination and Release Agreement and reduced payroll expenses after the June 2002 restructuring.
Restructuring Costs
In June 2002, the Company underwent a significant restructuring involving management changes and cost control to lower personnel and facilities expenses as the Company refocused its efforts solely on its red-light video enforcement contracts for CrossingGuard installations. The Company terminated 19 full-time employees, affecting all departments, and offices were consolidated into smaller facilities. During the quarter ended June 30, 2002, the Company recorded restructuring costs of $743,000 primarily comprised of $332,000 in employee severance agreements and estimated lease obligations associated with closing its Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in connection with the Providence office lease and in 2003 in connection with the San Diego office.
Capitalized Systems Costs Impairment
During the quarter ended June 30, 2002, the Company determined that potential citation revenues from certain CrossingGuard installations in two cities would not exceed the cost of the underlying carrying value of the capitalized systems. These contracts were signed in the early stages of CrossingGuard development and
the site selection procedures and contract terms have since been improved. In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company wrote off capitalized systems cost of $794,000 and recorded a corresponding impairment charge in operating expenses. Ongoing revenues from these installations are expected to offset future costs of system operations.
Goodwill Impairment Loss
On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, the Company will test goodwill for impairment on an annual basis, or whenever indicators of impairment are identified. The Company completed the transitional impairment test of goodwill during the quarter ended June 30, 2002 and concluded that no impairment existed on January 1, 2002, when the standard was adopted. Management considers the Company's quoted stock price to be the best indicator of fair value for purposes of performing these analyses.
Based on the decline of the Company's stock price during the second and third quarters of 2002, however, the fair value was recomputed using the quoted quarter-end stock prices. Such computations resulted in goodwill impairment charges of $3,000,000 and $5,500,000 recorded as operating expenses during the respective 2002 quarters. The Company continues to monitor goodwill for potential impairment.
Gain on Royalty Assignment
On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU") with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the Company's rights to royalty income under the license agreement between the Company and ACI ("ACI License"). CLA is owned and controlled by Alan M. Wiener, Alvin J. Siteman and Robert M. Carroll, former directors and shareholders of the Company. The MOU also provided a schedule for advances by CLA to provide interim financing to the Company during the period prior to the closing. Upon closing on September 30, 2002, CLA paid the Company $3.1 million in cash (less advances) for the irrevocable assignment of its royalty rights under the ACI License from July 1, 2002 and in perpetuity. No obligations or other rights of the Company were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI deferred income and $60,000 in related professional fees, the Company recorded a $2,812,000 gain on this royalty assignment on September 30, 2002. The elimination of ACI unbilled contract revenue and deferred income were recorded as non-cash reductions.
Other Expense - -------------
For 2002, net other expense was $319,000 as compared with net other expense of $187,000 in the year-earlier period. In 2002, other expense included interest expense of $217,000 as compared to $65,000 in 2001, and both years included $106,000 of amortization expense related to the assigned value of warrants outstanding and being amortized over their remaining life. Interest expense was higher in 2002 in comparison to 2001 as 2001 only included three and one-half months of NTS interest expense.
Loss from Investment in Affiliate - ---------------------------------
The pre-merger loss from investment in affiliate recorded in 2001 of $81,100 reflected Nestor's portion of NTS losses realized under the equity method of accounting prior to the merger, and limited by Nestor's net investment in the subsidiary as of December 31, 2000. Effective as of the merger, NTS operating results are included in the consolidated financial statements.
Net Loss - --------
During 2002, the Company experienced a loss of $12,634,000, as compared with a loss of $1,565,000 in the prior year. For the year ended December 31, 2002, loss per share was $2.50 per share, as compared with a loss per share of $0.54 in the corresponding period of the prior fiscal year. For the year ended December 31,
2002, there was outstanding a weighted average of 5,047,611 shares (post reverse split), as compared to 2,881,877 shares in the year-earlier period.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk. ---------------------------------------------------------
The Company has long term obligations, however the interest rate is fixed. The Company also has a convertible note payable at prime plus 1.25% through its January 2006 maturity. The Company does not hedge against this exposure. Management assesses their exposure to these risks as immaterial.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data. -------------------------------------------
See annexed financial statements.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ------------------------------------------------------------------
On January 6, 2003, the Company filed with the Securities and Exchange Commission a current report on Form 8-K dated January 2, 2003 to disclose the change in Certifying Accountants. Ernst & Young LLP audited the Company's financial statements for the year ended December 31, 2001. Their opinion on the 2001 financial statements did not contain an adverse opinion or disclaimer of opinion nor was it qualified or modified as to uncertainty, audit scope or accounting principles except that it included a paragraph indicating that there was substantial doubt about the Company's ability to continue as a going concern. There have been no disagreements with Ernst & Young LLP relating to any matters of accounting principles or practices, financial statements, disclosures or auditing scope or procedures for the year ended December 31, 2001, which disagreements, if not resolved to the satisfaction of Ernst & Young LLP, would have caused it to make a reference to the subject matter of the disagreement(s), in connection with its report. During the year ended December 31, 2001 and the subsequent period preceding Ernst & Young's resignation, no event occurred that is required to be disclosed pursuant to paragraph (a)(1)(v) of Item 304 of Regulation S-K.
On January 2, 2003, the Company's Audit Committee of the Board of Directors engaged the independent accounting firm, Carlin, Charron & Rosen LLP, 50 Exchange Terrace, Providence, Rhode Island 02903, a member of the Securities and Exchange Commission practice section of the AICPA, to audit the fiscal year ended December 31, 2002. During the fiscal year ended December 31, 2002 or any subsequent interim period prior to engaging Carlin, Charron & Rosen LLP, the Company did not consult Carlin, Charron & Rosen LLP regarding the application of accounting principles to a specific transaction or with respect to the type of audit opinion that might be rendered on the Company's financial statements or any matter to be disclosed pursuant to paragraph (a)(2) of Item 304 of Regulations S-K.
ITEM 9A.
ITEM 9A. Controls and Procedures. -----------------------
Nestor, Inc. management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) and 15d-15(e) as of December 31, 2003. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2003. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation.
PART II
ITEM 8.
CONSOLIDATED FINANCIAL STATEMENTS ---------------------------------
FORM 10-K ---------
December 31, 2003 -----------------
NESTOR, INC. ------------
CONTENTS --------
Page No. --------
Independent Auditors' Reports 27
Consolidated Balance Sheets - December 31, 2003 and 2002 29
Consolidated Statements of Operations - For the Years Ended December 31, 2003, 2002 and 2001 30
Consolidated Statements of Stockholders' Equity - For the Years Ended December 31, 2003, 2002 and 2001 31
Consolidated Statements of Cash Flows - For the Years Ended December 31, 2003, 2002 and 2001 32
Notes to Consolidated Financial Statements 33
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Nestor, Inc. East Providence, Rhode Island
We have audited the accompanying consolidated balance sheets of Nestor, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. Our audit also included the financial statement schedule for the years ended December 31, 2003 and 2002 listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 2003 and 2002 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nestor, Inc. at December 31, 2003 and 2002 and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/Carlin, Charron & Rosen, LLP
Providence, Rhode Island March 16, 2004
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Nestor, Inc.
We have audited the accompanying consolidated statements of operations, stockholders' equity and cash flows for the year ended December 31, 2001. Our audit also included the financial statement schedule listed for the year ended December 31, 2001 in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of Nestor, Inc.'s operations and its cash flows for the year ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that Nestor, Inc. will continue as a going concern. As discussed in Note 1, the Company is currently expending cash in excess of cash generated from operations, as revenues are not yet sufficient to support operations and the Company has incurred significant losses. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are discussed in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
/s/Ernst & Young LLP
Providence, Rhode Island February 26, 2002
See Independent Auditors' Reports and Notes to the Financial Statements.
NESTOR, INC. NOTES TO THE FINANCIAL STATEMENTS
NOTE 1 - NATURE OF OPERATIONS
A. Organization Nestor, Inc. (the "Company") was organized on March 21, 1983 in Delaware to develop and succeed to certain patent rights and know-how which the Company acquired from its predecessor, Nestor Associates, a limited partnership. Two wholly-owned subsidiaries, Nestor Traffic Systems, Inc. ("NTS") and Nestor Interactive, Inc. ("Interactive"), were formed effective January 1, 1997. Effective November 7, 1998, the Company ceased further investment in the Interactive subsidiary. CrossingGuard, Inc., a wholly owned subsidiary of NTS, was formed July 18, 2003 in connection with the financing discussed in Note 6. All intercompany transactions and balances have been eliminated. The Company's principal office is located in East Providence, RI.
The Company's current focus is to offer customers products and services to be utilized in intelligent traffic management applications. Its leading product is its CrossingGuard video-based red light enforcement system and services, sold and distributed exclusively by NTS. Effective July 1, 2002, the Company assigned its royalty rights in the field of financial services, substantially eliminating ongoing product royalty revenue from prior non-traffic related lines of business.
B. Liquidity and management's plans The Company has incurred significant losses to date and at December 31, 2003 has an accumulated deficit. The 2003 consolidated financial statements do not include any adjustments that might result should the Company not be able to continue as a going concern. In previous years similar conditions led the Company's auditors to modify their opinions to address going concern uncertainties. Management believes that with the significant financing obtained in 2003, the Company's strong liquidity at December 31, 2003 and its current contracts with municipalities, the Company will be able to continue the development and upgrading of its products and sustain operations through the end of 2004. There can be no assurance, however, that the Company's operations will be sustained or be profitable in the future, or that the Company's product development and marketing efforts will be successful.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: A. Cash equivalents The Company considers all highly liquid debt instruments purchased with an original maturity of 90 days or less to be cash equivalents.
B. Accounts receivable Accounts receivable represent balances due from customers, net of an $84,213 reserve for doubtful accounts at December 31, 2003. The Company considered accounts receivable at December 31, 2002 to be fully collectible, and accordingly, no allowance for doubtful accounts was necessary. In determining the need for an allowance, objective evidence that a single receivable is uncollectible as well as an historical pattern of collections of accounts receivable that indicate that the entire face amount of a portfolio of accounts receivable may not be collected is considered at each balance sheet date.
C. Unbilled contract revenue Unbilled contract revenue represents revenue earned by the Company in advance of being billable under customer contract terms. Under the terms of some current contracts, the Company cannot bill the municipality until the court has collected the citation fine. Management records unbilled contract revenue in these situations at a net amount, based upon a historical pattern of collections by the courts for the municipalities. The pattern of collections on these citations is continually reviewed and updated by management.
D. Inventory Inventory is valued at the lower of cost or market, with cost determined by the first-in, first-out basis and consists mostly of equipment to be installed as capitalized system costs.
E. Property and equipment & depreciation and amortization Property and equipment are recorded at cost. Depreciation and amortization are calculated using the straight-line method at rates sufficient to write off the cost of the assets over their estimated useful lives.
F. Goodwill Goodwill represents the excess of cost over the fair value of net assets acquired. Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," requires that goodwill be tested for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Goodwill is reviewed for impairment using the Company's quoted stock price as a measurement of the Company's fair value of assets, including goodwill, and liabilities. Any resulting goodwill impairment will be charged to operations.
G. Product and patent development costs The costs of development of the Company's software - which consist primarily of labor and outside consulting and are an inherent cost of the Company's business - and costs of research and development are expensed until technological feasibility has been established for the product. Thereafter, all software production costs are capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized on a straight-line basis over the estimated economic life of the product. The Company currently has no costs eligible for capitalization under the American Institute of Certified Public Accountants Statement of Position 98-1.
Patent-development costs are expensed or capitalized, as appropriate. Amortization of capitalized costs is on a straight-line basis over the shorter of the estimated economic life, or statutory life, of the patent.
H. Revenue recognition Nestor Traffic Systems, Inc.: Revenue is derived mainly from the lease of products which incorporate NTS's software and the delivery of services based upon such products. Lease and service fees include software licenses and processing service fees tied to citations issued to red-light violators. NTS provides equipment (either under sales or operating lease agreements), postcontract customer support (PCS) and engineering services. In arrangements that include multiple elements, some of which include software, the total arrangement fee is allocated among each deliverable based on the relative fair value of each of the deliverables determined based on vendor-specific objective evidence.
Product Sales - The Company recognizes the revenue allocable to product sales upon delivery of the product.
Lease and Service Fees - The Company recognizes lease and service fee revenue from operating lease arrangements with customers over the terms of the lease agreements. The majority of NTS's CrossingGuard revenues are expected to be generated from fees received from red-light violation citations issued by the system and associated services. Revenues are recognized upon the issuance of the related tickets.
Nestor, Inc.: During 2001, revenue was derived from software licenses (Initial License Fees), user fees (Monthly License Fees), PCS and engineering services. In software arrangements that included multiple elements, the Company allocated the total arrangement fee among each deliverable based on the relative fair value of each of the deliverables determined based on vendor-specific objective evidence as per AICPA Statement of Position 97-2 - Software Revenue Recognition.
Software Licenses - During 2001, the Company recognized revenue allocable to software licenses upon delivery of the software product to the end user, unless the fee was not fixed or determinable or collectibility was not probable. The Company considered all arrangements with payment terms extending beyond twelve months and other arrangements with payment terms longer than normal not to be fixed or determinable. If the fee was not fixed or determinable, revenue was recognized as payments became due from the customer. In most situations, the Company considered its acceptance terms as perfunctory. Arrangements that included acceptance terms that were not considered perfunctory were not recognized until acceptance occurred. If collectibility was not considered probable, revenue was recognized when the fee was collected. Revenue on arrangements with customers who were not the ultimate users (distributors, other resellers, etc.) was not recognized until the software was delivered to an end user.
Both companies above: Postcontract Customer Support - PCS includes maintenance agreements. Revenue allocable to PCS is recognized on a straight-line basis over the period the PCS is provided or upon issuance of related tickets if a component of ticket fees.
Engineering Services - Engineering services range from installation, training, and basic consulting to modeling, software modification and customization to meet specific customer needs. For arrangements that include customization or modification of the software, or where software services are otherwise considered essential, revenue is recognized using contract accounting. Revenue from these software arrangements is recognized on a percentage-of-completion method with progress-to-completion measured based upon estimated total costs. Contracts may include penalty provisions relating to timely performance and delivery. Penalties are charged to operations as incurred.
I. Shipping and handling costs Shipping and handling costs are capitalized if part of a leased system or included in engineering services expense.
J. Research and development Research and development in 2002 and 2003 represents costs associated with the NTS product line and consists principally of payroll and related costs, facilities costs and the cost of prototype components.
K. Income taxes The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and the tax bases of assets and liabilities, and are measured using enacted tax rates and tax laws that will be in effect when the differences are expected to reverse. The primary component of the deferred tax asset as of December 31, 2003 and 2002, which is fully reserved, is net operating loss carry forwards.
Although the Company reports consolidated results and balances for financial reporting purposes, the individual companies file separate tax returns. Due to operating losses throughout the reporting periods, no provision for income tax was made in 2003, 2002 or 2001.
L. Earnings (loss) per share and common stock The Company reports its earnings (loss) per share ("EPS") in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). Basic EPS is calculated by dividing the net income (loss) by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed giving effect to common stock equivalents and other dilutive securities, unless the computation results in anti-dilution. Diluted per share computations are not presented since the effect would be anti-dilutive.
Common stock and loss per share as previously reported have been adjusted to a post-reverse split basis.
M. Reclassification Certain operating expenses reported at December 31, 2001 have been reclassified to conform to the December 31, 2002 presentation. These reclassifications had no effect on 2001 net loss as previously reported.
N. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
O. Concentrations of credit risk The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable. The Company places its cash and temporary cash investments with high credit quality institutions. At times such investments may be in excess of the FDIC limit. However, senior management continually reviews the financial stability of these financial institutions. The Company routinely assesses the financial strength of its customers, most of which are municipalities, and, as a result, believes that its trade accounts receivable credit risk exposure is limited. The Company does not require collateral from its customers.
P. Accounts payable Included in accounts payable is a $221,000 note payable to a vendor with a balance of $75,604 at December 31, 2003. The note bears interest at 8% and monthly principal and interest payments of $19,218 are due through April 2004.
Q. Stock option plans The Company accounts for stock option awards granted to officers, directors and employees (collectively "employees") under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, no stock-based employee compensation cost is reflected in net income, as all options granted to employees under these plans have been granted at no less than fair market value on the date of grant. The Company applies the disclosure only provision of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation" ("SFAS 123") and SFAS No. 148, "Accounting for Stock-based Compensation-Transition and Disclosure ("SFAS 148") for such employee stock option awards. The Company accounts for stock option awards granted to consultants under the fair value recognition provisions of SFAS 123. Under this method, options are valued using the Black-Scholes option pricing model, and the calculated option value is recorded as an expense in the financial statements.
For purposes of providing pro forma disclosures for employee grants, the fair value for options was estimated at the date of grant using the Black-Scholes pricing model with the following weighted average assumptions:
2003 2002 2001 ---- ---- ----
Expected life (years) 8 8 8 Average risk-free interest rate 1.6-6.8% 2.6 to 6.8% 4.2 to 6.8% Volatility 117.4% 109.8% 105.9% Dividend yield 0% 0% 0%
The weighted-average fair value of options granted during 2003, 2002 and 2001 was $2.55, $1.80 and $5.10, respectively. The Company recognizes forfeitures as they occur.
Had the Company determined compensation expense for the Plan in accordance with the fair value methodology prescribed by SFAS 123, the Company's pro forma net loss and loss per share would have been:
Years Ended December 31, --------------------------------------------- 2003 2002 2001 ---- ---- ----
Net loss - reported $(4,890,458) $(12,634,263) $(1,565,054) Add (Deduct): total stock-based compensation expense determined under fair-value based method for all awards, net of related tax effects $ 149,965 $ (22,464) $ (23,679) Pro Forma - net loss $(4,740,493) $(12,656,727) $(1,588,733) Pro forma net loss per share - basic and diluted $ (0.37) $ (2.51) $ (0.55)
For the purposes of this disclosure, the estimated fair value of the options is amortized to expense over the options' vesting periods. The effects on pro forma disclosures of applying SFAS 123 may not be representative of the effects on pro forma disclosures of future years.
NOTE 3 - CAPITALIZED SYSTEM COSTS: Equipment, installation and in some cases interest costs related to operating lease contracts are capitalized and, after acceptance by the municipality (customer), are depreciated generally over a three to five year estimated useful life. Revenues realized from these agreements, generally in the form of per-citation fees, are expected to be adequate to cover the capitalized and future costs related to these agreements. Most leases contain minimum payment requirements, which currently aggregate to $2,746,512 in 2004, $2,528,824 in 2005, $1,918,527 in 2006, $1,235,568 in 2007 and $902,917 in 2008, but management expects that these annual amounts could increase and extend to future years as additional intersections are installed. A substantial portion of this equipment is collateral for the Company's leases payable (see Note 7).
December 31, ------------ 2003 2002 ---- ---- Equipment under operating leases: Work-in-process $ 248,693 $ 381,030 Installed and accepted 4,358,062 1,884,611 ----------- ----------- 4,606,755 2,265,641
Less: Accumulated depreciation (1,091,847) (328,858) ----------- -----------
Net investment in leased equipment $3,514,908 $ 1,936,783 =========== ===========
NOTE 4 - PROPERTY AND EQUIPMENT - NET:
December 31, ------------ 2003 2002 ---- ---- Office furniture and equipment $ 140,475 $ 140,475 Computer equipment 1,747,454 1,607,256 Demonstration equipment 7,726 125,562 Leasehold improvements 231,915 227,872 ----------- ----------- 2,127,570 2,101,165 Less: Accumulated depreciation (1,742,405) (1,614,425) ----------- ----------- $ 385,165 $ 486,740 =========== ===========
Depreciation and amortization expense of $239,878 and $235,361 on the above assets was recorded for the years ended December 31, 2003 and 2002, respectively.
In 2003, the Company disposed of $117,189 of demonstration equipment. Additionally, in 2003 equipment with a cost of $17,020 was transferred to inventory at net book value. In 2002, the Company sold or disposed of $56,877 in office furniture and equipment, $13,194 of computer equipment and $2,442 of leasehold improvements. The loss on disposal is included in Other expense - net.
NOTE 5 - GOODWILL AND OTHER TANGIBLE ASSETS: On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS 142, the Company will test goodwill for impairment on an annual basis, or whenever indicators of impairment are identified. The Company completed the transitional impairment test of goodwill during the quarter ended June 30, 2002 and concluded that no impairment existed on January 1, 2002, when the standard was adopted. Management considers the Company's quoted stock price to be the best indicator of fair value for purposes of performing these analyses.
Based on the decline of the Company's stock price during the second and third quarters of 2002, however, the fair value was recomputed using the quoted quarter-end stock prices. Such computations resulted in goodwill impairment charges of $3,000,000 and $5,500,000 recorded as operating expenses during the respective 2002 quarters. The Company continues to monitor goodwill for potential impairment.
As all of the goodwill recorded on the Company's books was created subsequent to June 30, 2001, no goodwill amortization was recorded during 2001, in accordance with SFAS No. 142. Since no amortization of goodwill had been recorded in 2001, adoption of SFAS No. 142 has had no pro forma effect on the net loss or earnings per share calculations for fiscal year 2001.
Amortization of other intangible assets has been immaterial to operating results to date.
NOTE 6 - NOTES PAYABLE: First Laurus Convertible Note: On July 31, 2003, the Company entered into a Securities Purchase Agreement ("the Agreement") with Laurus Master Fund, Ltd. ("Laurus"). Pursuant to the Agreement, the Company issued to Laurus a Convertible Note ("Note") in the principal amount of $2,000,000 that bore interest at the prime rate plus 1.25% (subject to a floor of 5.25%) and matured on July 31, 2005. The initial principal payment of $20,000 was due in December 2003 and increased over the term of the loan such that aggregate principal payments totaled $950,000 in 2004 and $1,030,000 in 2005. The Note allowed repayment, at the Company's option, in cash or, subject to certain limitations, through the issuance of shares of the Company's common stock at the fixed conversion price of $1.55 per
share if the then current market price was above 120% of the fixed conversion price. Laurus also had a conversion right at any time or from time to time at or prior to maturity, to convert the Note into shares of the Company's common stock at the fixed conversion price, subject to adjustments for shares of common stock issued for less than the fixed conversion price (unless exempted pursuant to the Agreement). The Company had the option of redeeming for cash any outstanding principal by paying 115% of such amount plus accrued but unpaid interest.
During November and December 2003, Laurus converted $85,250 of the Note into 55,000 shares of Nestor common stock at $1.55 per share. On January 14, 2004, the Company satisfied its remaining payment obligations on the Note by issuing 492,904 shares of its common stock to Laurus at the fixed conversion price of $1.55 per share and redeeming the remaining $1,150,750 note balance by a "payment" of $1,340,972, which included accrued interest and a $172,613 prepayment penalty. This "payment" was netted against the proceeds from the Second Laurus Convertible Note (see below), resulting in $98,028 net cash proceeds to the Company.
The Company filed a Registration Statement on Form S-2 on September 2, 2003 (SEC File No. 333-108432), registering the resale of shares issued to Laurus under that note, pursuant to a registration rights agreement. That registration became effective on November 26, 2003. The Company filed a post-effective amendment to that registration statement on January 30, 2004, which became effective on February 13, 2004. Laurus has agreed to limit the volume of its sales of the Company's common stock to a percentage of the total daily volume of open market sales of the Company's common stock on its principal trading market whenever the previous trading day's volume weighted average price for shares of the Company's common stock is between $2.00 and $5.00 per share (inclusive) until January 14, 2008. The percentage to which Laurus will limit its sales varies with the previous day's volume weighted average price. If the relevant price is $2.00 or more and less than $3.00, the limit is 15% of the daily volume on the day of the sale; if the relevant price is $3.00 or more and less than $4.00, 22% of the daily volume on the day of the sale; and if the relevant price is $4.00 or more and not greater than $5.00, 30% of the daily volume on the day of the sale. Laurus may seek, and the Company may give, its approval to exceed those volume limitations in negotiated transactions.
The note was collateralized by a first lien on all available CrossingGuard, Inc. assets. Laurus has a general security interest in four customer contracts assigned by NTS to CrossingGuard, Inc. and NTS has pledged the common stock of CrossingGuard, Inc. In connection with financing, Laurus was paid a fee of $80,000, had certain of its expenses reimbursed and received a warrant to purchase 140,000 shares of the Company's common stock. The warrant exercise price is as follows: $1.78 per share for the purchase of up to 83,000 shares; $1.94 per share for the purchase of an additional 33,000 shares; and $2.25 per share for the purchase of an additional 24,000 shares. The warrant exercise price may be paid in cash, in shares of the Company's common stock (if the fair market value of a single share of common stock exceeds the value of the per share warrant exercise price), or by a combination of both. The warrant expiration date is July 31, 2008.
Also in connection with financing, Management Services Group/Sage Investments, Inc. ("Sage") was paid a fee of $80,000 and will receive $4,444 per month for nine months for continuing consultation. Sage received warrants to purchase 14,000 shares of Company stock as follows: $1.78 per share for the purchase of up to 8,300 shares; $1.94 per share for the purchase of an additional 3,300 shares; and $2.25 per share for the purchase of an additional 2,400 shares. The warrant expiration date is July 31, 2008.
The Black-Scholes values of the warrants issued in connection with this financing totaled $143,980 (Laurus) and $14,398 (Sage) and were recorded as additional paid-in capital. The Laurus warrant value was recorded as a discount on the note payable. During the quarter ended September 30, 2003, the Company amortized $11,998 of the discount as interest expense. As the Note was satisfied on January 14, 2004, the remaining unamortized discount of $113,984, deferred interest of $55,148 and deferred financing fees of $131,228 had negligible continuing value and were consequently written off to interest expense
(discount and deferred interest) and financing fees, respectively, at December 31, 2003. The warrants have not been exercised as of December 31, 2003.
Second Laurus Convertible Note: On January 14, 2004, the Company also entered into a securities purchase agreement with Laurus. Pursuant to that agreement, the Company issued to Laurus a new convertible note in the principal amount of $1,500,000 that bears interest at the prime rate plus 1.25% (subject to a floor of 5.25% per year) and matures on January 14, 2006. Principal repayments commence May 2004 with $375,000 due in 2004, $1,012,500 due in 2005 and $112,500 due in 2006. The net proceeds from the new note will be used for the construction, installation, and maintenance of traffic surveillance systems and for other general corporate purposes. The new note may be repaid at the Company's option, in cash or, subject to limitations, through the issuance of shares of its common stock. The Company has an option to pay the monthly amortized amount in shares of its common stock at the fixed conversion price of $3.50 per share if the shares are registered with the Securities and Exchange Commission for public resale and the then current market price is 120% above the fixed conversion price. The Company agreed to file a registration statement with the Commission to register the public resale by Laurus of the common stock to be issued upon conversion of the note and to pay Laurus damages if that registration statement is not declared effective by the Commission by July 30, 2004. The note includes a right of conversion in favor of Laurus. If Laurus exercises its conversion right at any time or from time to time at or prior to maturity, the new note will be convertible into shares of the Company's common stock at the fixed conversion price, subject to adjustments for stock splits, combinations, and dividends. In conjunction with this transaction, Sage is entitled to a fee of $60,000 and an affiliate of Laurus received a management fee of $45,000 and reimbursement of certain expenses. The first lien, security interest and pledge of CrossingGuard, Inc. stock from the first Laurus Note continued to this second note.
Silver Star Convertible Note: On October 15, 2003, the Company sold a $2,000,000 convertible note ("Silver Star Note") to Silver Star Partners I, LLC ("Silver Star"). The Silver Star Note was due on January 15, 2004 and bore interest at the rate of 7% per year. The Company's obligations under the note could, at the Company's option, be satisfied, in whole or part, by issuing shares of the Company's common stock to Silver Star at a conversion price equal to the gross price from the first offering of a similar number of such shares made after October 15, 2003.
On December 31, 2003, the Company exercised its option to satisfy the Silver Star note and accrued interest by issuing 676,384 shares of Nestor common stock at $3.00 per share. See Common and Preferred Stock footnote also.
Silver Star has the right to require the Company to register with the SEC Silver Star's resale of all shares of common stock that it owns as soon as practicable after Silver Star requests that registration. The Company is obligated to pay all expenses associated with that registration. The Company has other obligations in connection with that registration, including causing the registration statement filed to remain continuously effective until the distribution of shares covered by the registration statement is complete and indemnifying Silver Star from liabilities it may incur resulting from any untrue statement or omission of a material fact in the registration statement and related documents and from other liabilities related to the registration. Danzell Investment Management, Ltd. received a 3% finders fee from the Company in connection with the Silver Star Note.
William B. Danzell is the Chief Executive Officer of Nestor, Inc., the President of Danzell Investment Management, Ltd. and the Managing Director of Silver Star Partners I, LLC. Robert M. Krasne, David N. Jordan and George L. Ball, each a director of Nestor, are each also affiliates of Silver Star Partners I, LLC. Stephen H. Marbut, a former director of Nestor, is also an affiliate of Silver Star Partners I, LLC. The sale of the note by Nestor to Silver Star Partners I, LLC and the satisfaction of our obligations under it by issuing common stock were approved by the directors of Nestor not affiliated with Silver Star Partners I, LLC.
NOTE 7 - LEASES PAYABLE: On June 28, 2001, NTS executed a Master Lease Purchase Agreement with Electronic Data Systems Corporation ("EDS"), whereby EDS provided lease financing to support installation of the NTS CrossingGuard product to municipalities under leasing terms. NTS received $3,183,180 in advances, drawn at $53,053 per approach contracted to fund system equipment, design and installation costs. Advances were collateralized by equipment delivered under leased CrossingGuard systems and were being repaid interest (20%) only for the first 6 months and principal and interest over the next 60 months from each advance date.
Payments were made as scheduled through February 2002, then the Company became delinquent on payments and fell out of compliance with the lease agreement. On January 10, 2003, the lease agreement was amended, pursuant to a letter agreement between NTS and EDS dated July 18, 2002, to provide: (i) a moratorium on NTS' interest obligations under the lease for the period from July 1, 2002 through June 30, 2003; (ii) a moratorium on all principal repayments through June 30, 2003, at which time regular monthly payments will resume; (iii) all lease payments in arrears as of June 30, 2002 will be accrued and payable as follows, $150,000 on September 30, 2003, $100,000 on December 31, 2003, and $37,590 on March 30, 2004; and (iv) effective July 1, 2002, the interest rate factor upon which the lease payments are based was lowered to 12% per annum. EDS will not extend additional financing under the Master Lease Purchase Agreement.
During 2003, the Company recorded $163,961 of EDS interest expense. In 2002 and 2001, the Company recorded $303,481 and $174,218 of EDS interest costs; $100,559 and $105,193 of which were capitalized as capitalized systems costs and $202,922 and $49,788 were expensed directly, respectively. In addition, $19,237 of EDS interest in 2001 was expensed by NTS pre-merger.
On January 26, 2004, the Company satisfied its remaining obligations to EDS by making a payment of $2,178,764. This transaction resulted in the Company recording a gain on early extinguishment of debt of $680,737 in January 2004.
NOTE 8 - RESTRUCTURING: In June 2002, the Company underwent a significant restructuring involving management changes and cost control to lower personnel and facilities expenses as the Company refocused its efforts solely on its red-light video enforcement contracts for CrossingGuard installations. The Company terminated 19 full-time employees, affecting all departments, and offices were consolidated into smaller facilities. During the quarter ended June 30, 2002, the Company recorded restructuring costs (which are separately disclosed in the Statement of Operations) of $743,000 primarily comprised of $332,000 in employee severance agreements and estimated lease obligations associated with closing its Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in connection with the Providence office lease and in 2003 in connection with the San Diego lease. After offsetting security and inventory deposits against restructuring costs and paying $142,000 and $119,000 in severance benefits, $15,000 and $89,000 in lease settlement costs and $62,000 and zero purchase commitment costs in 2003 and 2002, respectively, $147,000 remains outstanding on the balance sheet as a restructuring reserve at December 31, 2003.
NOTE 9 - COMMON AND PREFERRED STOCK:
Private Placement and Silver Star Note Conversion: The Company sold 2,843,000 shares of its common stock to accredited investors in private placements conducted during December 2003 (1,596,560 shares), and January 2004. The shares were sold at $3.00 per share, with net proceeds to Nestor, excluding expenses of the offering, of $2.76 per share totaling $7,846,680. The Company has continuing obligations in connection with the registration of the resale of the shares offered, including causing the registration statement filed to remain continuously effective for two years or, if earlier, until the sale of shares covered by the registration statement is complete and
indemnifying the holders from liabilities it may incur resulting from any untrue statement or omission of a material fact in the registration statement and related documents and from other liabilities related to the registration.
On December 31, 2003, after the initial closing of the private placement above, the Company exercised its right to convert the Silver Star Note and accrued interest (see Note 6 also) by issuing 676,384 shares of Nestor common stock at $3.00 per share.
Although the proceeds from the initial closing above were received in December 2003 and the Silver Star note conversion was effective December 31, 2003, the associated stock certificates were not issued until January 2004. As such, these 2,272,944 shares are classified as "Stock Pending Issuance" on the balance sheet at December 31, 2003.
Laurus Note Conversion: As more fully described in Note 6, Laurus elected to convert $85,250 of their first note into 55,000 shares of Nestor common stock in 2003. In January 2004, Laurus further converted $764,000 of the note into 492,904 shares of Nestor common stock. Both conversions were priced at $1.55 per share.
Silver Star Equity Financing: In a first closing on January 15, 2003, Silver Star purchased 49 million shares of Nestor common stock (pre-reverse stock split) for $2,376,500 and on April 16, 2003, completed a second closing, purchasing an additional 4,013,557 shares (post-reverse stock split) for $1,946,575. Danzell Investment Management, Ltd., in which William B. Danzell, the Managing Director of Silver Star, serves as president, has provided investment-related services (including consulting services) to the Company and has received a fee for services rendered in an amount equal to 3% of the cash proceeds generated by the Company in connection with the financing transactions with Silver Star. Upon completion of the second closing, Silver Star owned 64% of the issued and outstanding shares of Company common stock (63.7% at December 31, 2003). See Form 8-K dated April 9, 2003 for further information.
One-for-Ten Reverse Stock Split: The Company filed a certificate of amendment to its certificate of incorporation on April 11, 2003, causing a one-for-ten reverse stock split of the outstanding shares of the Company common stock effective on that date. The Company's common stock began trading on a post reverse split basis on April 21, 2003 under the new trading symbol "NESO" (previously "NEST"). These financials reflect common stock and loss per share on a post-split basis.
Stock Issued in Connection with NTS Merger: In September 2001, the Company completed a merger with NTS (Note 16), which resulted in the issuance of 32,338,558 shares of Nestor, Inc. common stock.
Preferred Stock: Series B Convertible Preferred Stock is convertible into Common Stock of the Company at any time on a share-for-share basis. Series B Convertible Preferred Stock has the same rights with respect to voting and dividends as the Common Stock, except that each share of Series B Convertible Preferred Stock has the right to receive $1.00 in liquidation before any distribution is made to holders of the Common Stock. The liquidation value of Series B Preferred was $190,000 at December 31, 2003 and $235,000 at December 31, 2002.
NOTE 10 - OPTIONS AND WARRANTS: On April 1, 1984, the Company adopted an Incentive Stock Option Plan under which the Board of Directors may grant incentive or non-qualified stock options to employees, directors and consultants to purchase shares of the Company's common stock at a price equal to the market price of the stock at the date of grant. The Company's Stock Option Plan has authorized the grant of options to employees for up to 245,000 shares (post-reverse split) of the Company's common stock. Options generally vest over three years and are exercisable for five
years from the date of grant. The options are not transferable except by will or domestic relations order.
On May 6, 1997, the Company adopted the 1997 Stock Option Plan under which the Board of Directors may grant incentive or non-qualified stock options to employees, directors and consultants to purchase shares of the Company's common stock at a price equal to the market price of the stock at the date of grant. In June 2001, the 1997 Stock Option Plan was amended to increase the aggregate number of options authorized to 500,000 shares (post-reverse split) of the Company's common stock. Options vest over four years and are exercisable for up to ten years from the date of grant, although most options currently outstanding expire eight years from the date of grant. The options are not transferable except by will or domestic relations order.
The following table presents the activity of the Company's Stock Option Plans for the years ended December 31, 2003, 2002 and 2001 on post-reverse split basis. The number of options granted and outstanding in 2001 rose significantly due to the conversion of 302,800 NTS stock options into 277,500 Nestor, Inc. stock options priced at $5.50. The number of options canceled in 2002 included unexercised options previously held by employees who were terminated in connection with the Company's restructuring. In 2003, options granted were to directors of the Company; many of which were canceled later in 2003 due to changes in the Board.
Years Ended December 31, ----------------------------------------------------------- 2003 2002 2001 ---- ---- ----
Weighted Weighted Weighted Av. Ex. Av. Ex. Av. Ex. Shares Price Shares Price Shares Price ---------------- ---------------- ----------------
Outstanding beginning of year 324,199 $6.50 395,121 $7.10 110,482 $12.80 Granted 176,250 3.34 36,800 2.00 344,584 5.90 Exercised --- --- --- --- 17,413 7.00 Canceled 188,052 4.85 107,722 7.10 42,532 12.30 ------- ------- ------- Outstanding- end of year 312,397 $5.75 324,199 $6.50 395,121 $ 7.10 ======= ======= =======
Options exercisable at year end 233,970 $6.80 224,730 $7.30 214,863 $ 8.20 ======= ======= =======
The following table presents weighted average price and life information about significant option groups outstanding at December 31, 2003.
Options Outstanding Options Exercisable ------------------------------- ------------------------- Weighted Average Weighted Weighted Number Remaining Average Number Averaged Range of Outstanding Contractual Exercise Exercisable Exercisable Exercise Prices at 12/31/03 Life (Years) Price at 12/31/03 Price - --------------- ----------- ------------ -------- ----------- -----------
$ 1.00 - $ 1.90 74,300 3.73 $ 1.45 17,321 $ 1.81 $ 5.50 126,485 3.51 5.50 120,802 5.50 $ 6.00 - $14.40 96,612 1.35 7.04 80,847 7.17 $15.00 - $28.90 15,000 1.12 20.97 15,000 2.60 ------- ---- ------- ------ ------ 312,397 2.78 $ 5.75 233,970 $ 6.80 ======= ==== ======= ======= ======
The Company, at the discretion of the Board of Directors, has granted warrants from time to time, generally in conjunction with the sale of
equities. During 2001, the Company issued 398,071 warrants in connection with the NTS merger and converted a premerger NTS warrant to purchase 9,166 common shares (post-reverse split). Transaction Systems Architects, Inc.'s ("TSAI") warrant to purchase 250,000 common shares (post-reverse split) expired on March 1, 2002, triggering the concurrent expiration of 125,000 NTS merger warrants. During 2003, the Company issued 154,000 warrants in connection with the convertible note financing. The following table presents warrants outstanding after adjusting to a post-reverse split basis:
Years Ended December 31, -------------------------------- 2003 2002 2001 ---- ---- ---- Eligible, end of year for exercise currently 660,936 532,141 907,141 ======== ======== ========
Warrants issued 154,000 --- 407,237 Low exercise price $ 1.78 $ --- $ 0.10 High exercise price $ 2.25 $ --- $ 12.80
The warrants outstanding as of December 31, 2003 are currently exercisable and expire at various dates through July 31, 2008. outstanding warrants entitle the owner to purchase one share of common stock for each warrant, at prices ranging from $0.10 to $12.80 per share (post-reverse split). In 2003, the one-for-ten reverse split impacted both the number of warrants and warrant prices proportionately. The exercise price of warrants outstanding at December 31, 2002 was adjusted downward as a result of anti-dilution provisions of the warrants and the completion of the Silver Star Partners I, LLC investment.
During the year ended June 30, 1996, the exercise price of 100,000 warrants issued in the prior year was reduced from $15.00 to $6.50 (post-reverse split). The maximum cumulative expense to be recorded by the Company upon exercise of these warrants will be $850,000. During the period ended December 31, 1996, the Company began recording, on a prorated basis, the maximum expense over the remaining life of the warrants. Accordingly, the Company recognized expenses totaling $106,000 in 2003, 2002 and 2001.
NOTE 11 - SEGMENT INFORMATION: A. Description of reportable segments Effective with the September 2001 merger, the Company has two reportable segments: Nestor, Inc. and Nestor Traffic Systems, Inc.
Nestor, Inc. produced and sold credit and debit card fraud detection products and database marketing products to financial institutions and processors of financial data until the Company entered into reseller license agreements with Applied Communications, Inc. on February 1, 2001 and with Retail Decisions, Inc. on May 18, 2001. In addition, all expenses associated with development, support and selling these products were transferred to these parties. Subsequent to the reseller agreements, Nestor, Inc. revenues were mainly royalties from these licenses until the Company assigned its royalty rights as of July 1, 2002. The NTS segment provides video-based monitoring systems and services for traffic safety, mainly to municipalities. Goodwill has been allocated to the NTS segment.
B. Measurement of segment profit or loss and segment assets The Company evaluates performance based on income or loss before investment income (loss). The accounting policies of the reportable segments are the same as those described elsewhere in these financial statements.
C. Segment income or loss and segment assets All revenues are from external customers. There are no intercompany sales.
Nestor Traffic Nestor, Inc. Systems, Inc. Totals ------------ -------------- ------ YEAR ENDED DECEMBER 31, 2003: Revenues $ 29,000 $ 2,677,000 $ 2,706,000 Segment net loss (528,000) (4,362,000) (4,890,000) Segment assets 5,702,000 10,597,000 16,299,000
YEAR ENDED DECEMBER 31, 2002: Revenues $ 665,000 $ 1,457,000 $ 2,122,000 Segment net income (loss) 3,591,000 (16,225,000) (12,634,000) Segment assets 598,000 8,603,000 9,201,000
YEAR ENDED DECEMBER 31, 2001: Revenues $3,073,000 $ 448,000 $ 3,521,000 Segment income (loss) 1,295,000 (2,779,000) (1,484,000) Segment assets 2,516,000 19,519,000 22,035,000
D. Geographic Information Revenues are attributed to countries based on the location of customers. All foreign revenues related to Nestor, Inc. All long-lived assets are located in the United States.
Years Ended December 31, --------------------------------------------------- 2003 2002 2001 ---- ---- ----
United States $2,705,534 $ 2,112,281 $ 3,450,613 Japan --- --- 46,844 Canada --- 9,293 23,467 ---------- ------------ ------------
$2,705,534 $ 2,121,574 $ 3,520,924 ========== ============ ============
E. Revenues from Major Customers
Years Ended December 31, --------------------------------------------------- 2003 2002 2001 ---- ---- ----
Customer A - Nestor, Inc. $ --- $ 629,569 $ 1,841,031 Customer B - Nestor, Inc. --- --- 832,000 Customer C - NTS 406,670 266,751 34,925 Customer D - NTS 399,067 --- --- Customer E - NTS 348,143 150,331 --- Customer F - NTS --- 293,911 218,023 Customer G - Nestor, Inc. --- --- 285,536
NOTE 12 - IMPAIRMENT CHARGE: During the quarter ended June 30, 2002, the Company determined that potential citation revenues from certain CrossingGuard installations in two cities would not exceed the cost of the underlying carrying value of the capitalized systems. These contracts were signed in the early stages of CrossingGuard development and the site selection procedures and contract terms have since been improved. In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company wrote off capitalized systems cost of $794,000 and recorded a corresponding impairment charge in operating expenses. Ongoing revenues from these installations are expected to offset future costs of system operations.
NOTE 13 - ROYALTY ASSIGNMENT: On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU") with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the Company's rights to royalty income under the license agreement between Nestor, Inc. and ACI ("ACI License") (Note 21). CLA is owned and controlled by three former directors and shareholders of the Company. The MOU also provided a schedule for advances by CLA to provide interim financing to the Company during the period prior to the closing. Upon closing on September 30, 2002, CLA paid the Company $3.1 million in cash (less advances) for the irrevocable assignment of its royalty rights under the ACI License from July 1, 2002 and in perpetuity. No obligations or other rights of the Company were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI deferred income and $60,000 in related professional fees, the Company recorded a $2,812,000 gain on this royalty assignment on September 30, 2002. The elimination of ACI unbilled contract revenue and deferred income were recorded as non-cash reductions.
NOTE 14 - OTHER EXPENSE - NET:
Other expense as reflected in the consolidated statements of operations consists of the following:
Years Ended December 31, -------------------------------------------- 2003 2002 2001 ---- ---- ----
Interest income $ 13,438 $ 11,229 $ 51,695 Interest expense (470,206) (217,023) (65,355) Expense relating to financing operations (106,484) (106,483) (106,483) Other income 64,130 --- --- Loss on disposal of fixed assets (5,291) (6,341) (66,666) ---------- --------- --------- Other expense - net $(504,413) $(318,618) $(186,809) ========== ========== ==========
NOTE 15 - INCOME TAXES: During 2003 and 2002, the Company recorded deferred tax assets primarily for the benefit of net operating losses in the amount of $1,742,000 and $1,573,000, respectively. The cumulative amount of these assets, which is $16,514,000 and $14,772,000 at December 31, 2003 and 2002, respectively, is fully reserved. Due to the Company's history of operating losses, management has concluded that realization of the benefit is not likely.
The Company has available at December 31, 2003, $41,142,000 and $26,700,000 of net operating loss carryforwards for federal and state purposes, respectively. Approximately $13,318,000 and $9,960,000 of these federal and state net operating loss carryforwards were acquired as part of the merger with NTS. These loss carryforwards may be applied against future taxable income and begin to expire in 2004.
Pursuant to Section 382 of the Internal Revenue Code, annual use of the tax loss carryforwards may be limited if there is a change in ownership. This limitation applies to the losses incurred by Nestor, Inc., as well as to the losses incurred by NTS. The use of state net operating losses may be limited in the future due to the apportionment of net operating losses among different states and varying net operating loss utilization requirements by state. The Company has not determined the effect of these limitations.
NOTE 16 - NESTOR TRAFFIC SYSTEMS, INC.: In January 2001, an agreement in principle was reached to combine the Company and NTS, by merging NTS into a wholly-owned subsidiary of the Company, with Nestor, Inc. in effect, becoming the surviving entity. On August 6, 2001, the Company filed Form S-4/A with the Securities and Exchange Commission. The combination was approved by the shareholders of both companies in meetings held on September 12, 2001.
On January 9, 2001, the Company and NTS entered into a secured note agreement with NTS Investors, LLC (an independent investment group ("Group")). The Group loaned NTS $4,000,000 as of February 1, 2001 with principal and interest at 8% due on December 31, 2001.
Upon consummation of the combination contemplated above, the Group converted the note and accrued interest to equity and increased its total investment to $8,000,000 in exchange for 16,757,368 pre-reverse stock split shares (representing approximately 33.34%) of post-merger Nestor, Inc. common stock. Concurrently, NTS shareholders exchanged their NTS common shares held for Nestor, Inc. common stock and, in the aggregate, received 15,581,190 pre-reverse stock split shares representing approximately 31% of post-merger Nestor, Inc. common stock.
In addition, the Group received a warrant right to acquire up to 2,980,712 additional shares of common stock exercisable at the same price at which currently outstanding warrants of Nestor, Inc. are exercisable, but only in the event the currently outstanding warrants are exercised, so as to maintain their initial ownership interest percentage. This warrant right decreased by 1,250,000 shares on March 1, 2002 with the expiration of TSAI's warrant on that date. In addition, the Group received a warrant to acquire 1,000,000 shares of the Company's common stock at $1.28 per share for three years as dilution protection against both the Company's and NTS's converted employee stock options outstanding at closing. Such warrants are treated as variable and, accordingly, are revalued quarterly with offsetting adjustments to additional paid-in capital. All shares above are on a pre-reverse stock split basis.
The following is a summary of the purchase price and allocation to the fair value of the assets acquired and liabilities assumed.
Value of common stock issued to consummate the merger $ 7,790,595 Value of options issued as a result of the merger 1,621,395 Value of warrants issued as a result of the merger 43,994 Acquisition costs 622,144 ----------- Total purchase price 10,078,128 Plus net NTS liabilities assumed by Nestor, Inc. 4,002,556 ----------- Goodwill $14,080,684 ===========
Fair values of assets acquired and liabilities assumed:
Cash and cash equivalents $ 361,804 Accounts receivable 166,765 Inventory 501,899 Fixed assets - net 2,240,614 Other assets 281,540 Note payable (4,000,000) Accounts payable and accrued expenses (1,519,444) Other current liabilities (286,710) Long term leases payable (1,749,024) ------------ Net liabilities assumed $(4,002,556) ===========
The following table presents the consolidated results of operations for the year ended December 31, 2001 on an unaudited pro forma basis as if the merger took place at the beginning of the period presented.
Revenues $ 4,435,000 Net loss $ 5,419,000 Loss per share, basic and diluted, pre-reverse stock split $ 0.13
On January 1, 1999, the Company entered into an exclusive license with NTS to apply certain proprietary technologies in the fields of using video and other sensors to analyze, monitor and respond to movement of persons or objects in vehicular, rail, air or other modes of transportation or supporting the foregoing. The license expires upon the expiration of the underlying patents protecting the technologies used in NTS's products. The license provides for royalties to the Company starting in 2000 equal to 5% of the gross margin realized from sales or licensing of products subject to the license, and increasing to 10% of the gross margin in calendar years 2001 and beyond. The license requires minimum annual royalties of $125,000 in 2001, $250,000 in 2002, $500,000 in 2003, $750,000 in 2004 and $1 million for each year thereafter, in order to maintain exclusive rights. The annual minimum royalties were recorded and eliminated in consolidation.
During 2001, NTS used facility and administrative services of the Company, including office space and executive, accounting and other support personnel. Prior to the September 2001 merger, facility and administrative fees charged to NTS were $397,000 in 2001. Post-merger charges were eliminated in consolidation.
NOTE 17 - RELATED PARTY TRANSACTIONS: Herbert S. Meeker, a former director of the Company, is a partner in the law firm of Brown Raysman Millstein Felder & Steiner, LLP, which the Company uses for legal services. For the years ended December 31, 2003, 2002, and 2001, the Company recorded an expense to Mr. Meeker's firm of $41,316, $7,254 and $121,065, respectively. In addition, for the years ended December 31, 2003 and 2002, the Company recorded $42,657 and $9,919 of fees relating to the 2003 Silver Star stock purchase agreement. Lastly, $369,501 of fees were recorded in 2001 as acquisition costs related to the NTS merger.
Bruce W. Schnitzer, a former director of the Company, is Chairman of Wand Partners, Inc., a private investment firm that the Company used for management consulting. For the year ended December 31, 2001, the Company recorded an expense for Wand Partners, Inc. of $49,636. In 2002, the Company reversed $71,848 of previously expensed Wand fees (recorded as a reduction to general and administrative expenses) in connection with a Termination and Release Agreement agreed to in principle prior to December 31, 2002 but dated January 15, 2003. Included in accrued liabilities at December 31, 2002 is $96,250 due to Wand Partners, Inc.
Benjamin Alexander, secretary of the Company (as of June 2003), is an attorney with the firm of Partridge, Snow and Hahn LLP, which the Company uses for legal services. For the year ended December 31, 2003, the Company recorded legal and stockholder expenses to Mr. Alexander's firm in the amounts of $63,973 and $24,354, respectively. In addition, $11,261 was recorded relating to the July 2003 Laurus financing, which was fully expensed as financing fees.
TSAI, the parent company of ACI, is a stockholder of the Company. Thomas H. Boje, Vice President, Corporate Development of TSAI, was a director of the Company April 2000 through 2001. For the years ended December 31, 2002 and 2001, the Company recorded revenues of $629,569 and $1,841,031, respectively from ACI. Further related party transactions with TSAI and ACI are discussed throughout these financial statements.
Deferred compensation of $79,131 was recorded and accrued for the period July 1, 2002 to December 31, 2002 for two officers of the Company. The deferral was paid in full January 2003.
See Note 6 for transactions with Silver Star and Laurus, Note 13 for royalty assignment to Churchill Lane Associates, LLC and Note 16 for transactions with Nestor Traffic Systems, Inc.
NOTE 18 - COMMITMENTS AND CONTINGENCIES: NTS entered into an operating lease dated June 21, 2000 for office and warehouse facilities in East Providence, Rhode Island. This lease provides for monthly rentals of $10,360 through July 2003 and then increases to $10,800 monthly through July 2005. Rent expense for this lease was $37,300 post-merger in 2001, $124,300 in 2002 and $126,500 in 2003.
NTS also leases office space in La Jolla, California. The July 17, 2002 operating lease called for monthly rent of $1,533 through the lease term expiration of July 31, 2003. NTS remains in the space on a month-to-month status at $1,691 per month. Rent expense was $8,500 in 2002 and $20,672 in 2003.
During 2000, the Company began leasing computer equipment under an operating lease agreement. The lease provides for monthly rent payments in arrears over a three-year term. At the end of the lease term, the Company may purchase the equipment at fair market value, extend the lease term or return the equipment. Rent expense was $20,504 in 2003 and $40,134 in 2002 and 2001.
NOTE 19 - LITIGATION: On November 6, 2003, the Company filed a complaint in the United States District Court for Rhode Island against Redflex Traffic Systems, Inc., alleging that Redflex's automated red light enforcement systems infringe on the Company's patent. Redflex denies this allegation. On November 25, 2003, the Company filed a complaint in the United States District Court for the District of Central California against Transol USA, Inc., alleging that Transol's automated red light enforcement systems infringe on the Company's patent. Transol has counterclaimed that Nestor's patent is invalid and that Transol does not infringe on it. Nestor was denied a preliminary injunction in the Transol litigation. The Company cannot give assurance that it will be successful in either action.
During April 2003, the former president of NTS resigned as a member of the board of directors of the Company. The president's employment with the Company and NTS terminated. The president filed a complaint against the Company and NTS in the Providence Superior Court seeking severance benefits, including twelve months salary of $180,000, upon termination. See Form 8-K dated April 9, 2003 for further information. The parties reached a mutually agreeable settlement on December 31, 2003, the terms of which are confidential. All claims have been dismissed.
On July 12, 2002, Baldwin Line Construction of Maryland, Inc. filed a lawsuit against Nestor Traffic Systems, Inc. in Fairfax County, Virginia, seeking $117,105 plus interest related to invoices they claimed were owed for construction work in Falls Church, Virginia. NTS and Baldwin reached a settlement agreement on April 22, 2003 whereby NTS paid $7,500 and all claims of each party were dismissed.
In the ordinary course of business, the Company is a defendant in certain claims and legal proceedings. In the opinion of management, the outcome of these matters will not have a material effect on the financial position of the Company.
NOTE 20 - CONTRACT TERMINATION RESERVE: A significant customer contract in the Rail line of business may be terminated by mutual agreement prior to its completion as a result of the Company's decision to focus its resources on CrossingGuard systems
and services. The Company accrued $125,000 of estimated contract termination fees in June 2003.
NOTE 21 - ACI LICENSE AGREEMENT: On February 1, 2001, the Company entered into a license agreement with ACI pursuant to which ACI was granted a worldwide, perpetual, non-revocable, non-transferable and non-exclusive license in the field of use of fraud detection (including money laundering detection) in electronic payments. ACI may brand, customize, and extend the software products covered by the license agreement as well as use the software programs as a development platform to develop new functional and new end-user products or applications subject to the terms and conditions of the license. In return, ACI is fully responsible and liable for the provision of services to its licensees. Nestor, Inc. had previously provided support, maintenance and enhancements for these products.
Under the new agreement, ACI paid a one-time license fee of $1,104,000 for source code license rights to the software products, and in addition, agreed to pay an ongoing royalty fee of 15% with a first year minimum of approximately $475,000. The license granted to ACI is for products that constituted a significant portion of the Company's gross revenues. During the quarter ended March 31, 2001, the Company recorded the one-time initial license fee of $1,104,000 in connection with this source code license. Reported ACI revenues thereafter decreased significantly due to the termination of the previous ACI contract that provided a 40% monthly license fee as well as additional engineering revenues. Expenses relating to these revenues have also decreased significantly because ACI hired thirteen employees from Nestor, Inc., effective February 1, 2001, and reimbursed the Company $13,000 per month for the continued use of Nestor, Inc. facilities and equipment prior to their office relocation in May 2001. Unbilled contract revenue and deferred income under the prior agreement were replaced by the new royalty amounts during the quarter to reflect the 15% royalty rate under the new agreement. During the quarter ended March 31, 2001, the Company recorded a non-cash reduction of $3,037,000 and a non-cash increase of $1,111,000 in unbilled contract revenue and deferred income related to these agreements.
Nestor continued to receive royalties under this agreement through June 30, 2002. Effective July 1, 2002, the Company assigned its ACI royalty rights to Churchill Lane Associates.
NOTE 22 - RETAIL DECISIONS, INC. LICENSE AGREEMENT: On May 18, 2001, Nestor entered into a license agreement with Retail Decisions, Inc. ("ReD") in which Nestor granted to ReD: (i) an exclusive (other than ACI), perpetual, fully-paid, worldwide license in the field of use of fraud and money laundering detection and risk management in certain defined industries; and (ii) a non-exclusive, perpetual, fully-paid, worldwide license solely for use in the field of use of customer relationship management in certain defined industries.
Additionally, Nestor transferred to ReD certain assets that were supportive of the technology licensed thereunder. The assets transferred to ReD by Nestor include all of the right, title and interest of Nestor in certain equipment, license agreements (excluding ACI) and trademark rights. To support its newly acquired license, ReD hired 13 of Nestor's employees.
ReD paid $1,800,000 to Nestor under the license agreement, and Nestor agreed, for certain marketing and transition services, to pay to ReD: (i) $500,000 which was paid on July 2, 2001; (ii) $250,000 which was paid on October 1, 2001; and (iii) $218,000 which was paid January 2, 2002. The Company recorded $832,000 as net license revenue in the second quarter of 2001 in connection with this agreement. No ongoing revenues have been realized from ReD.
NOTE 23 - RECENT ACCOUNTING PRONOUNCEMENTS: In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure and Amendment to FASB No. 123", which provides three optional transition methods for entities that decide to voluntarily adopt the fair value recognition principles of SFAS No. 123, "Accounting for Stock Issued to
Employees", and modifies the disclosure requirements of that Statement. The Company has not adopted the fair value recognition principles of SFAS No. 123; therefore this Statement has had no effect upon the Company's consolidated financial condition or results of operations. The Company has provided the additional quarterly disclosures required by SFAS No. 148.
See Independent Auditors' Reports.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant. -------------------------------------------------------------------
Incorporated by reference from the Company's definitive proxy or information statement to be filed with the Securities and Exchange Commission not later than 120 days following the end of the Company's fiscal year.
The Company has adopted a written code of ethics that applies to all employees, including but not limited to, its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of Nestor's code of ethics is available without charge by writing to: Nestor, Inc., 400 Massasoit Avenue, Suite 200, East Providence, Rhode Island 02914-2020, Attention: Nigel P. Hebborn.
ITEM 11.
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.
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.
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.
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.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K. ---------------------------------------------------------------
(a) The following documents are filed as part of this report:
(1) The financial statements of the Company and accompanying notes, as set forth in the contents to the financial statements annexed hereto, are included in Part II, Item 8.
(2) Consolidated Financial Statement Schedule: Valuation and Qualifying Accounts and Reserves
All other schedules are omitted because such information is not applicable
(3) Exhibits numbered in accordance with Item 601 of Regulation S-K and filed herewith.
See Exhibit Index.
(b) Reports on Form 8-K:
On October 17, 2003, the Corporation filed with the Securities and Exchange Commission a current report on Form 8-K dated September 23, 2003 under Items 5 and 7, reporting the increase in the number of directors of the Corporation to seven, the election to the Board of Albert H. Cox, Terry Fields and Susan A. Keller and the purchsae by Silver Star Partners I, LLC of a convertible note in the principal amount of $2,000,000 from the Corporation.
On October 28, 2003, the Corporation filed with the Securities and Exchange Commission a current report on Form 8-K dated October 22, 2003 under Items 5 and 7, reporting the resignation of Stephen H. Marbut from the Corporation's Board of Directors and the election of George L. Ball thereto.
PART IV ITEM 15 (a)(2)
NESTOR, INC. ------------
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE ----------------------------------------- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES ----------------------------------------------
Balance at Charged Charged Deductions Balance Beginning to to Other from at End of of Period Expense Accounts Reserve Period --------- ------- -------- ------- ------
Allowances deducted from accounts receivable:
Year Ended ---------- December 31, 2001 $4,145 $(4,145) $ --- $ --- $ ---
December 31, 2002 $ --- $ --- $ --- $ --- $ ---
December 31, 2003 $ --- $84,213 $ --- $ --- $84,213
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized.
NESTOR, INC. (Registrant)
/s/ William B. Danzell --------------------------------------------- William B. Danzell, Chief Executive Officer
/s/ Nigel P. Hebborn --------------------------------------------- Nigel P. Hebborn, Chief Financial Officer
Date: March 29, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signatures Title Date - ---------- ----- ----
/s/ Robert M. Krasne - -------------------- Robert M. Krasne Chairman of the Board March 29, 2004
/s/ George L. Ball - ------------------ George L. Ball Director March 29, 2004
/s/ Albert H. Cox, Jr. - ---------------------- Albert H. Cox, Jr. Director March 29, 2004
/s/ William B. Danzell President - ---------------------- Chief Executive Officer William B. Danzell and Director March 29, 2004
/s/ Terry E. Fields - ------------------- Terry E. Fields Director March 29, 2004
/s/ David N. Jordan - ------------------- David N. Jordan Director March 29, 2004
/s/ Susan A. Keller - ------------------- Susan A. Keller Director March 29, 2004
INDEX OF EXHIBITS
Exhibit No. Description of Exhibit ------- ----------------------
3.1 Restated Certificate of Incorporation.
4.1 Specimen Certificate for shares of Common Stock, $.01 par value, of the Registrant filed as an Exhibit to the Company's Registration Statement on Form S-2, as amended (File No. 333-108432), is hereby incorporated by reference.
10.1 Securities Purchase Agreement dated August 1, 1994, between the Company and Wand/Nestor Investments L.P. ("Wand") filed as Item 5 of the Company's report on Form 8-K dated August 8, 1994, is hereby incorporated herein by reference.
10.2 Standby Financing and Purchase Agreement dated as of March 16, 1995 between the Company and Wand, filed as an Exhibit to the Company's Current Report on Form 8-K, dated March 16, 1995, is hereby incorporated by reference.
10.3 First Amended and Restated Standby Financing and Purchase Agreement dated June 30, 1995 between the Company and Wand, filed as an Exhibit to the Company's Current Report on Form 8-K, dated July 7, 1995, is hereby incorporated by reference.
10.4 Securities Purchase and Exchange Agreement between the Company and Wand/Nestor Investments L.P., filed as an Exhibit to the Company's Current Report on Form 8-K dated January 30, 1996, is hereby incorporated by reference.
10.5 Securities Purchase Agreement between the Company and Wand/Nestor Investments L.P., filed as an Exhibit to the Company's Current Report on Form 8-K dated March 7, 1996, is hereby incorporated by reference.
10.6 Asset Purchase Agreement and License Agreement between the Company and National Computer Systems, Inc., filed as an Exhibit to the Company's Current Report on Form 8-K dated June 11, 1996, is hereby incorporated by reference.
10.7 PRISM Non-Exclusive License Agreement between the Company and Applied Communications, Inc., filed as an Exhibit to the Company's Current Report on Form 8-K dated September 19, 1996, is hereby incorporated by reference. Portions of the Exhibit omitted, pursuant to a grant of confidential treatment.
10.8 License Agreement dated as of March 28, 1997, between Nestor, Inc. and Total System Services, Inc. filed as an Exhibit to the Company's Current report on Form 8-K dated April 8, 1997, is hereby incorporated by reference. Portions of the Exhibit omitted, pursuant to a grant of confidential treatment.
10.9 Amendment to the PRISM Non-Exclusive License Agreement dated as of April 18, 1997, between Nestor, Inc. and Applied Communications, Inc. filed as an Exhibit to the Company's Current Report on Form 8-K dated April 30, 1997 is hereby incorporated by reference. Portions of the Exhibit omitted pursuant to a grant of confidential treatment.
10.10 Exclusive License Agreement between Nestor, Inc. and Nestor Traffic Systems, Inc. dated January 1, 1999 filed as an Exhibit to the Company's Current Report on Form 8-K dated March 25, 1999.
10.11 Secured Note Agreement by and among Nestor, Inc., Nestor Traffic Systems, Inc. and NTS Investors LLC dated January 9, 2001 and filed as an Exhibit to the Company's Current Report on Form 8-K on January 18, 2001 is hereby incorporated by reference.
10.12 License Agreement between Nestor, Inc. and ACI Worldwide, Inc. dated February 1, 2001 filed as an Exhibit to the Company's Current Report on Form 8-K on February 9, 2001 is hereby incorporated by reference.
Exhibit No. Description of Exhibit ------- ----------------------
10.13 License Agreement dated May 18, 2001 between the Company and Retail Decisions, Inc. filed as an exhibit to the Company's current report on Form 8K dated May 18, 2001 which is hereby incorporated by reference.
10.14 Security Purchase Agreement dated July 31, 2003 between Nestor, Inc. and Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003, which is hereby incorporated by reference.
10.15 Convertible Note dated July 31, 2003 made by Nestor, Inc. to Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003 which is hereby incorporated by reference.
10.16 Registration Rights Agreement dated July 31, 2003 between Nestor, Inc. and Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003, which is hereby incorporated by reference.
10.17 Common Stock Purchase Warrant dated July 31, 2003 issued by Nestor, Inc. to Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003 which is hereby incorporated by reference.
10.18 Stock Pledge Agreement dated July 31, 2003 between Nestor Traffic Systems, Inc. and Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003, which is hereby incorporated by reference.
10.19 Pledge and Security Agreement dated July 31, 2003 between CrossingGuard, Inc. and Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003 which is hereby incorporated by reference.
10.20 Guaranty dated July 31, 2003 by CrossingGuard, Inc. to Laurus Master Fund, Ltd. filed as an exhibit to the Company's current report on Form 8-K dated July 31, 2003 which is hereby incorporated by reference.
10.21 Nestor, Inc. Incentive Stock Option Plan, as amended, filed as an Exhibit to the Company's Registration Statement on Form S-8, filed May 5, 1987, is hereby incorporated herein by reference
10.22 Nestor, Inc. 1997 Incentive Stock Option Plan, as amended, filed as an Exhibit to the Company's Registration Statement on Form S-8, filed May 16, 1997, is hereby incorporated by reference.
10.23 Securities Purchase Agreement dated April 28, 1998 with Transaction Systems Architects, Inc. to purchase 2,500,000 common shares of the Company and a warrant for an additional 2,500,000 common shares filed as an Exhibit to Nestor's Current Report on Form 8-K dated May 7, 1998 is hereby incorporated by reference.
10.24 Nestor Traffic Systems, Inc., Form of Subscription Agreement dated March 25, 1999, to sell a 37.5% equity position in its common stock and issue a warrant for an additional 17.5% common stock interest filed as an Exhibit to Nestor's Current Report on Form 8-K dated April 23, 1999 is hereby incorporated by reference.
10.25 Security Purchase Agreement dated January 14, 2004 between Nestor, Inc. and Laurus Master Fund, Ltd. filed as an Exhibit to Nestor's Current Report on Form 8-K dated December 31, 2003 is hereby incorporated by reference.
10.26 Convertible Note dated January 14, 2004 made by Nestor, Inc. to Laurus Master Fund, Ltd. filed as an Exhibit to Nestor's Current Report on Form 8-K dated December 31, 2003 is hereby incorporated by reference.
Exhibit No. Description of Exhibit ------- ----------------------
10.27 Registration Rights Agreement dated January 14, 2004 between Nestor, Inc. and Laurus Master Fund, Ltd. filed as an Exhibit to Nestor's Current Report on Form 8-K dated December 31, 2003 is hereby incorporated by reference.
10.28 Redemption and Conversion Agreement dated January 14, 2004 between Nestor, Inc. and Laurus Master Fund, Ltd. filed as an Exhibit to the Company's Registration Statement on Form S-2, as amended (File No. 333-108432), is hereby incorporated by reference.
10.29 Placement Agent Agreement dated December 24, 2003 among Nestor, Inc., Sanders Morris Harris, Inc., and Barrett & Company, Inc. filed as an Exhibit to the Company's Registration Statement on Form S-2, as amended (File No. 333-108432), is hereby incorporated by reference.
10.30 Registration Rights Agreement dated December 31, 2003 among Nestor, Inc., Sanders Morris Harris, Inc., and Barrett & Company, Inc. filed as an Exhibit to the Company's Registration Statement on Form S-2, as amended (File No. 333-108432), is hereby incorporated by reference.
31.1 Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(b) and 15d-14(b), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Chief Financial Officer required by ExchangeA ct Rules 13a-14(b) and 15d-14(b), as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
99.1 Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995.
*Certification is not deemed "filed" for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. Such certification is not deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.