-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MoQscCv8HbM7dSSKJQdFNiE5OFbYuc9BgakXnDO3Ev4591kpzehxkDRyel68D0Od LStjofFT1Ljr9EE/eJsg6g== 0000720851-01-500007.txt : 20010409 0000720851-01-500007.hdr.sgml : 20010409 ACCESSION NUMBER: 0000720851-01-500007 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NESTOR INC CENTRAL INDEX KEY: 0000720851 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 133163744 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-12965 FILM NUMBER: 1591333 BUSINESS ADDRESS: STREET 1: ONE RICHMOND SQ CITY: PROVIDENCE STATE: RI ZIP: 02906 BUSINESS PHONE: 4013319640 MAIL ADDRESS: STREET 1: 1 RICHMOND SQUARE CITY: PROVIDENCE STATE: RI ZIP: 02906 10-K/A 1 form10ka.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10K/A FIRST AMENDMENT [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended December 31, 2000 ----------------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------- -------------- Commission file Number 0-12965 NESTOR, INC. (Exact name of registrant as specified in its charter) DELAWARE 13-3163744 - ------------------------ ------------------ (State of incorporation) (I.R.S. Employer Identification No.) One Richmond Square, Providence, Rhode Island 02906 ------------------------------------------------------ (Address of principal executive offices) (Zip Code) (401) 331-9640 ------------- (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 Par Value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X --------- Exhibit Index is on Page: 40 The aggregate market value of the 8,044,936 shares of voting stock held by non-affiliates of the registrant, based on the average bid and asked prices of such stock on February 28, 2001 was $5,908,201. The number of shares outstanding of the Registrant's Common Stock at February 28, 2001 was 17,688,449. DOCUMENTS INCORPORATED BY REFERENCE. Information to be included in registrant's definitive proxy or information statement to be filed with the Commission not later than 120 days following the end of registrant's fiscal year is incorporated by reference in Part III of the Form 10-K. SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized. NESTOR, INC. (Registrant) /s/David Fox, President and CEO ------------------------------- Date: April 2, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Title Date - ---------- ----- ---- /s/Leon N Cooper Co-Chairman of the Board and Director April 2, 2001 - -------------------- /s/Charles Elbaum Co-Chairman of the Board and Director April 2, 2001 - -------------------- /s/David L. Fox President, Chief Executive Officer April 2, 2001 - -------------------- and Director /s/Herbert S. Meeker Secretary and Director April 2, 2001 - -------------------- /s/Sam Albert Director April 2, 2001 - -------------------- /s/Thomas H. Boje Director April 2, 2001 - -------------------- /s/Jeffrey Harvey Director April 2, 2001 - -------------------- /s/Thomas F. Hill Director April 2, 2001 - -------------------- /s/Bruce Schnitzer Director April 2, 2001 - -------------------- CONSOLIDATED FINANCIAL STATEMENTS --------------------------------- FORM 10K/A ---------- December 31, 2000 ----------------- THIS DOCOMENT IS BEING FILED FOR THE PURPOSE OF CORRECTING AN ERROR THAT APPEARED IN NOTE 16 OF THE NESTOR, INC. FINANCIAL STATEMENTS INCLUDED IN PART II, ITEM 8 AND NOTE 11 OF THE NESTOR TRAFFIC SYSTEMS, INC. (SUBSIDIARY) FINANCIAL STATEMENTS INCLUDED IN ITEM 14 (a) (2) EXHIBIT 21.2 INCLUDED HEREWITH. NESTOR, INC. Part II ------------ Item 8 CONTENTS Page No. Independent Auditor's Report 20 Consolidated Balance Sheets - 21 December 31, 2000 and 1999 Consolidated Statements of Operations - 22 For the Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Stockholders' Equity - 23 For the Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows - 24 For the Years Ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements 25 Part II Item 8 Report of Independent Auditors The Board of Directors and Stockholders of Nestor, Inc. We have audited the accompanying consolidated balance sheets of Nestor, Inc. as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 2000 and 1999 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nestor, Inc. at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Providence, Rhode Island February 26, 2001 NESTOR, INC. Consolidated Balance Sheets --------------------------- DECEMBER 31, ASSETS 2000 1999 --------------------------- CURRENT ASSETS: Cash and cash equivalents ...................... $ 150,035 $ 1,048,802 Accounts receivable, net of allowance for doubtful accounts ........................ 693,555 984,318 Unbilled contract revenue ...................... 1,260,884 1,200,484 Due from affiliate ............................. 322,952 320,459 Other current assets ........................... 91,042 161,809 ------------ ------------ Total current assets ......................... 2,518,468 3,715,872 Long term unbilled contract revenue .............. 2,036,896 1,965,532 Investment in affiliate .......................... 81,100 710,690 Property and equipment at cost, net of accumulated depreciation ................ 177,377 269,917 Deferred development costs ....................... 32,000 56,000 Patent development costs ......................... 76,862 55,894 ------------ ------------ TOTAL ASSETS ..................................... $ 4,922,703 $ 6,773,905 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Line of credit ................................. $ 419,769 $ -- Accounts payable ............................... 253,696 271,397 Accrued employee compensation .................. 265,779 314,202 Accrued liabilities ............................ 472,983 547,799 Deferred income ................................ 1,306,016 1,371,217 ------------ ------------ Total current liabilities .................... 2,718,243 2,504,615 NONCURRENT LIABILITIES: Long term deferred income ...................... 2,036,896 1,965,532 ------------ ------------ Total liabilities ............................ 4,755,139 4,470,147 ------------ ------------ Commitments and contingencies .................. -- -- STOCKHOLDERS' EQUITY: Preferred stock, $1.00 par value, authorized 10,000,000 shares; issued and outstanding: Series B - 235,000 shares at December 31, 2000 and 345,000 shares at December 31, 1999 ............................ 235,000 345,000 Common stock, $.01 par value, authorized 30,000,000 shares; issued and outstanding: 17,688,449 shares at December 31, 2000 and 17,499,327 shares at December 31, 1999 ....... 176,884 174,993 Warrants and options ........................... 843,434 736,951 Additional paid-in capital ..................... 27,434,129 26,574,123 Retained deficit ............................... (28,521,883) (25,527,309) ------------ ------------ Total stockholders' equity ................... 167,564 2,303,758 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ....... $ 4,922,703 $ 6,773,905 ============ =========== Significant related party transactions are described in Note 13. The Notes to the Financial Statements are an integral part of this statement. NESTOR, INC. Consolidated Statements of Operations -------------------------------------
YEARS ENDED DECEMBER 31, 2000 1999 1998 --------------------------------------------- Revenue (Note 13): Software licensing ...................... $ 2,537,511 $ 3,872,016 $ 1,352,071 Engineering services .................... 1,114,911 1,242,763 746,007 Tangible product sales .................. -- -- 143,298 ------------- ------------ ------------ Total revenue ........................ 3,652,422 5,114,779 2,241,376 ------------- ------------ ------------ Operating expenses: Engineering services .................... 966,681 1,023,046 2,066,558 Tangible product costs .................. -- -- 54,010 Research and development ................ 1,247,205 920,918 2,112,746 Selling and marketing ................... 1,493,968 1,218,476 1,831,697 General and administrative .............. 1,493,345 1,209,888 1,413,340 ------------- ------------ ------------ Total operating expenses ............. 5,201,199 4,372,328 7,478,351 ------------- ------------ ------------ Income (loss) from operations .............. (1,548,777) 742,451 (5,236,975) Other expense - net ....................... (106,675) (97,386) (26,178) ------------- ------------ ------------ Income (loss) before income taxes and investment loss ...................... (1,655,452) 645,065 (5,263,153) Income taxes ............................... -- -- -- Loss from investment in affiliate .......... (1,339,122) (1,481,889) -- ------------- ------------ ------------ Net loss ................................... $ (2,994,574) $ (836,824) $ (5,263,153) ============= ============ ============ Loss Per Share: Net loss ................................... $ (2,994,574) $ (836,824) $ (5,263,153) Dividends accrued on preferred stock ....... -- -- 151,396 ------------ ------------ ------------ Net loss available for common stock ........ $ (2,994,574) $ (836,824) $ (5,414,549) ============= ============ ============ Loss per share, basic and diluted .......... $ (0.17) $ (0.05) $ (0.36) ============= ============ ============ Shares used in computing loss per share: Basic and diluted ....................... 17,901,602 17,844,327 15,249,932 ============= ============ ============ The Notes to the Financial Statements are an integral part of this statement.
Nestor, Inc. Consolidated Statement of Stockholders' Equity ----------------------------------------------
Common Stock Preferred Stock Additional Warrants -------------------- ---------------------- Paid-in Retained and Shares Amount Shares Amount Capital (Deficit) Options Total ------ ------ ------ ------ ---------- --------- -------- ----- Balance at December 31, 1997 9,403,987 $ 94,040 1,615,871 $1,710,347 $12,579,920 $(19,427,332) $523,984 $(4,519,041) Issuance of Common Stock 2,557,104 25,571 -- -- 5,060,282 -- -- 5,085,853 Conversion of Preferred Stock to Common Stock 1,223,255 12,232 (1,223,255) (1,294,882) 1,282,650 -- -- -- Premium on Conversion of Preferred Stock Series B to Common Stock 19,200 192 -- -- (192) -- -- -- Dividends on Preferred Stock Series D paid in Common Stock and cash 8,889 89 -- (17,941) 17,827 -- -- (25) Dividend accrued on Preferred Stock Series D -- -- -- 8,900 (8,900) -- -- -- Repurchase of Preferred Stock Series D -- -- (27,616) (41,424) -- -- -- (41,424) Conversion of Redeemable Convertible Preferred Stock to Common Stock 4,266,892 42,669 -- -- 5,823,568 -- -- 5,866,237 Dividends accrued on Redeemable Convertible Preferred Stock -- -- -- -- (142,496) -- -- (142,496) Costs incurred in connection with Redeemable Preferred conversion and TSAI Common Stock purchase -- -- -- -- (108,103) -- -- (108,103) Accretion of value of warrants -- -- -- -- -- -- 106,483 106,483 Loss for the year ended December 31, 1998 -- -- -- -- -- (5,263,153) -- (5,263,153) ---------- -------- ---------- ----------- ----------- ------------ -------- ------------ Balance at December 31, 1998 17,479,327 $174,793 365,000 $ 365,000 $24,504,556 $(24,690,485) $630,467 $ 984,331 Conversion of Preferred Stock to Common Stock 20,000 200 (20,000) (20,000) 19,800 -- -- -- Issuance of equity by subsidiary -- -- -- -- 2,049,767 -- -- 2,049,767 Accretion value of warrants -- -- -- -- -- -- 106,484 106,484 Loss for the year ended December 31, 1999 -- -- -- -- -- (836,824) -- (836,824) ---------- -------- ---------- ----------- ------------ ------------ -------- ----------- Balance at December 31, 1999 17,499,327 $174,993 345,000 $ 345,000 $26,574,123 $(25,527,309) $736,951 $ 2,303,758 Issuance of Common Stock 79,122 791 -- -- 84,846 -- -- 85,637 Conversion of Preferred Stock to Common Stock 110,000 1,100 (110,000) (110,000) 108,900 -- -- -- Issuance of equity by subsidiary -- -- -- -- 666,260 -- -- 666,260 Accretion value of warrants -- -- -- -- -- -- 106,483 106,483 Loss for the year ended December 31, 2000 -- -- -- -- -- (2,994,574) -- (2,994,574) ---------- -------- ---------- ----------- ------------ ------------ -------- ----------- Balance at December 31, 2000 17,688,449 $176,884 235,000 $ 235,000 $27,434,129 $(28,521,883) $843,434 $ 167,564 ========== ======== ========== ========== =========== ============ ======== =========== The Notes to the Financial Statements are an integral part of this statement.
NESTOR, INC. Consolidated Statements of Cash Flows -------------------------------------
YEARS ENDED DECEMBER 31, 2000 1999 1998 -------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ........................................... $ (2,994,574) $ (836,824) $ (5,263,153) Adjustments to reconcile net loss to net cash used by operating activities: Write-down for impairment loss .................. -- -- 790,641 Depreciation and amortization ................... 116,540 120,257 114,810 Loss from investment in affiliate ............... 1,339,122 1,481,889 -- Expenses charged to operations relating to options, warrants and capital transactions ..... 106,483 106,484 106,483 Changes in assets and liabilities: (Increase) decrease in accounts receivable .... 290,763 (471,570) 44,464 (Increase) in unbilled contract revenue ........ (131,764) (2,397,648) (477,906) (Increase) decrease in other assets ............ 70,767 (168,053) (98,649) (Decrease) increase in accounts payable and accrued expenses ......................... (124,624) 279,101 199,750 (Decrease) increase in deferred income ......... 6,163 2,244,213 684,304 ------------- ----------- ------------ Net cash provided (used) by operating activities (1,321,124) 357,849 (3,899,256) ------------- ----------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Advances to affiliate - net ........................ (45,764) (320,459) -- Purchase of property and equipment ................. -- (61,337) (132,209) Patent development costs ........................... (20,968) (55,894) -- ------------ ----------- ------------ Net cash used by investing activities (66,732) (437,690) (132,209) ------------ ----------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of obligations under capital leases ...... (16,317) (46,540) (47,246) Proceeds from notes payable/line of credit ......... 419,769 -- 250,000 Repayment of notes payable ......................... -- -- (250,000) Redemption of Preferred Series D Stock ............. -- -- (41,424) Proceeds from issuance of common stock - net ....... 85,637 -- 4,977,749 Payments of dividends on preferred stock ........... -- -- (69,070) ------------ ----------- ------------ Net cash provided (used) by financing activities 489,089 (46,540) 4,820,009 ------------- ----------- ------------ Net change in cash and cash equivalents ............. (898,767) (126,381) 788,544 Cash and cash equivalents - beginning of year ....... 1,048,802 1,175,183 386,639 ------------ ----------- ------------ Cash and cash equivalents - end of year ............. $ 150,035 $ 1,048,802 $ 1,175,183 ============ =========== ============ SUPPLEMENTAL CASH FLOWS INFORMATION: Interest paid ...................................... $ 10,603 $ 13,054 $ 20,350 ============ =========== ============ Income taxes paid .................................. $ -- $ -- $ 37,500 ============ =========== ============ Significant non-cash transactions are described in Notes 3, 5, 7, 8 and 12 The Notes to the Financial Statements are an integral part of this statement.
NOTES TO THE FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: A. ORGANIZATION Nestor, Inc. (the "Company") was organized on March 21, 1983 in Delaware to exploit, develop and succeed to certain patent rights and know-how which the Company acquired from its predecessor, Nestor Associates, a limited partnership. The Company's principal office is located in Providence, RI. The accompanying financial statements include the accounts of Nestor, Inc. in 1999 and 2000 and Nestor, Inc., Nestor Traffic Systems, Inc. ("NTS") and Nestor Interactive, Inc. ("Interactive") in 1998. NTS and Interactive were organized effective January 1, 1997 as two wholly owned subsidiaries. Effective November 7, 1998, the Company ceased further investment in the Interactive subsidiary. Any future marketing or development of Interactive's product has been transferred to Nestor, Inc. All intercompany transactions and balances have been eliminated. On March 25 and November 30, 1999, NTS sold in the aggregate a 58.1% common-stock interest to a private group of investors (Note 12). In accordance with Company policy, no gain was recognized on these transactions, and the Company recorded an increase in the equity value of its investment in affiliate. As a result of these transactions, the Company changed from consolidation to equity accounting for its remaining interest in NTS for the year ended December 31, 1999. In June 2000, NTS sold additional shares of its common stock to private investors, bringing the Company's ownership of NTS to 34.62%. As discussed in Note 16, in January 2001, an agreement in principle was reached to combine the Company and NTS by merging NTS into a wholly-owned subsidiary of the Company with Nestor, Inc., in effect, becoming the surviving entity. B. CASH EQUIVALENTS For the purpose of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of 90 days or less to be cash equivalents. C. UNBILLED CONTRACT REVENUES Unbilled contract revenues represent primarily minimum guaranteed monthly license fees (See F and G below) where a customer pays a portion of the license fees over the software license term (usually five years) based on a contractually predetermined minimum volume of transactions. D. DEPRECIATION AND AMORITIZATION Depreciable assets are recorded at cost. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the respective assets or lease terms. Maintenance and repairs are expensed as incurred. Major renewals and betterments are capitalized. E. PRODUCT AND PATENT DEVELOPMENT COSTS The costs of development of the Company's software - which consist primarily of labor and outside consulting and are an inherent cost of the Company's business - and costs of research and development are expensed until technological feasibility has been established for the product. Thereafter, all software production costs are capitalized and subsequently reported at the lower of unamortized cost or net realizable value. Capitalized costs are amortized on a straight-line basis over the estimated economic life (three to five years) of the product. Patent-development costs are expensed or capitalized, as appropriate. Amortization of capitalized costs is on a straight-line basis over the shorter of the estimated economic life, or statutory life, of the patent. F. DEFERRED INCOME Corresponding with unbilled contract revenues, deferred income represents primarily minimum guaranteed monthly license fees (see C above and G below) where a customer pays a portion of the license fees over the software license term (usually five years) based on a contractually predetermined minimum volume of transactions. Additionally, in certain instances, the Company bills and/or collects payment from customers prior to the delivery of the software product or performance of contracted maintenance or services, resulting in deferred income. G. REVENUE RECOGNITION The Company derives revenue from software licenses (Initial License Fees), user fees (Monthly License fees), other postcontract customer support (PCS) and engineering services. Postcontract customer support includes maintenance agreements. Engineering services range from installation, training, and basic consulting to modeling, software modification and customization to meet specific customer needs. In software arrangements that include multiple elements, the Company allocates the total arrangement fee among each deliverable based on the relative fair value of each of the deliverables determined based on vendor-specific objective evidence. As of January 1, 1998, the Company adopted AICPA Statement of Position 97-2 - Software Revenue Recognition ("SOP 97-2"), which is effective for transactions entered into in 1998. The most significant impact of SOP 97-2 on the Company's revenue recognition accounting policies is that for contracts with multiple elements, revenue, in some instances, may be recognized later than under past practices. Revenue is recognized as follows: Software Licenses - The Company recognizes the revenue allocable to software licenses upon delivery of the software product to the end user, unless the fee is not fixed or determinable or collectibility is not probable. The Company considers all arrangements with payment terms extending beyond twelve months and other arrangements with payment terms longer than normal not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. In most situations, the Company considers its acceptance terms as perfunctory. Arrangements that include acceptance terms that are not considered perfunctory are not recognized until acceptance has occurred. If collectibility is not considered probable, revenue is recognized when the fee is collected. Revenue on arrangements with customers who are not the ultimate users (distributors, other resellers, etc.) is not recognized until the software is delivered to an end user. Product returns or exchanges are charged to operations as incurred. Where the Company anticipates significant returns of products sold, the Company establishes an allowance for anticipated returns or exchanges at the time of sale. If customer acceptance is uncertain, revenue is recognized upon approval by the customer. Postcontract Customer Support - Revenue allocable to PCS is recognized on a straight-line basis over the period the PCS is provided. Software Services - Arrangements that include software services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. When software services are considered essential, revenue under the arrangement is recognized using contract accounting (see below). When the software services are not considered essential, the revenue allocable to the software services is recognized as the services are performed. Contract Accounting - For arrangements that include customization or modification of the software, or where software services are otherwise considered essential, revenue is recognized using contract accounting. Revenue from these software arrangements is recognized on a percentage-of-completion method based upon costs incurred to date in relation to estimated total costs. Training revenue is recognized upon the completion of training sessions with the customer. H. REVENUE CONCENTRATION The Company realizes a significant volume of business from Applied Communications, Inc. (ACI). In 2000, 1999 and 1998, revenues from ACI constituted 63%, 61% and 28%, respectively, of total revenues. I. CONCENTRATIONS OF CREDIT RISK The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable. The Company places its cash and temporary cash investments with high credit quality institutions. At times such investments may be in excess of the FDIC insurance limit. The Company routinely assesses the financial strength of its customers and, as a result, believes that its trade accounts receivable credit risk exposure is limited. The Company does not require collateral from its customers. Management believes the allowance carried for doubtful accounts receivable is adequate to cover potential losses associated with uncollectible accounts receivable. J. ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. K. EARNINGS (LOSS) PER SHARE The Company reports its earnings (loss) per share ("EPS") in accordance with the provisions of the Financial Accounting Standards Board Statement No. 128, Earnings Per Share ("FAS 128"). Basic EPS is calculated by dividing the income available to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed giving effect to common stock equivalents and other dilutive securities, unless the computation results in anti-dilution. NOTE 2 - ACCOUNTS RECEIVABLE, NET OF ALLOWANCE FOR DOUBTFUL ACCOUNTS: December 31, -------------------------- 2000 1999 ---- ---- Trade accounts receivable $ 697,700 $ 988,463 Allowance for doubtful accounts (4,145) (4,145) --------- --------- Accounts receivable, net of allowance for doubtful accounts $ 693,555 $ 984,318 ========= ========= NOTE 3 - DEFERRED DEVELOPMENT COSTS: The Company began, in the quarter ended September 30, 1996, a project to customize its PRISM fraud detection system for a customer. By the end of 1997, the Company had deferred $575,000 of costs in connection with engineering and installation of the project. Management believed that these costs would be fully recovered over the five year term of the contract. In view of the level of revenue generated by this contract, at December 31, 1998, the Company evaluated the carrying value of the deferred contract costs, utilizing estimated future contract revenues and ongoing customer support costs, appropriately discounted. In accordance with FAS 121 - "Impairment of Long Lived Assets," the Company wrote-down deferred development costs to $80,000 with an offsetting charge to engineering services. The residual deferred costs are being amortized on a straight-line basis over the remaining term of the contract. NOTE 4 - PROPERTY AND EQUIPMENT AT COST - NET: Useful Life in Years or December 31, Lease Term ------------------------ ----------- 2000 1999 ---- ---- Office furniture and equipment $ 234,706 $ 234,706 5 - 7 Leased computer equipment under capital leases 113,893 113,893 5 Computer equipment 1,268,855 1,268,855 3 - 5 ---------- ---------- 1,617,454 1,617,454 Less: Accumulated depreciation and amortization 1,440,077 1,347,537 ---------- ---------- $ 177,377 $ 269,917 ========== ========== Depreciation and amortization expense on the above assets of $92,540, $96,257 and $114,810, was recorded for the years ended December 31, 2000, 1999, and 1998, respectively. Accumulated depreciation and amortization includes $63,741, $40,963 and $18,184 of amortization related to leased equipment under capital leases at December 31, 2000, 1999 and 1998, respectively. NOTE 5 - INTANGIBLE ASSET: On March 31, 1997, the Company purchased from Cyberiad Software, Inc. ("Cyberiad"), a Rhode Island corporation, substantially all of Cyberiad's assets for use in the Company's Interactive subsidiary product. In this transaction, the Company issued 200,000 shares of its common stock to Cyberiad and agreed to assume approximately $10,500 of Cyberiad's liabilities. Accordingly, the Company recorded as an intangible asset the excess of its acquisition cost over the fair value of the net liabilities assumed ($394,517) and began to amortize this asset over 36 months. Amortization expense recorded in the year ended December 31, 1997 was $98,629. Since the Company ceased further investment in the Interactive subsidiary (see Note 1) and future realization of the asset was uncertain, the remaining value of this asset was written off in November 1998. NOTE 6 - LINE OF CREDIT: On March 24, 1999, the Company entered into a $1,000,000 Line of Credit agreement with Transaction Systems Architect, Inc. ("TSAI"). The loan is secured by the royalty stream and other fees produced by the Company's License Agreements with Financial Services Division customers. As of December 31, 2000, $419,769 had been advanced against the loan. The Company did not require additional advances through February 28, 2001 when the loan matured. Principal payments are due in twelve equal monthly installments ($34,981) beginning March 1, 2001. Interest is based on the prime interest rate plus 1% and is due quarterly in arrears. Included in accrued expenses at December 31, 2000 is $4,296 of interest due to TSAI. NOTE 7 - COMMON AND PREFERRED STOCK: On April 29, 1998, Nestor sold to Transaction Systems Architects, Inc. ("TSAI") $5 million of newly issued common stock at a price of $2 per share and a warrant to purchase an additional 2.5 million shares at $3 per share expiring March 1, 2002 (Note 8). Proceeds from the sale consisted of $4.5 million in cash and surrender of a $500,000 note owed to TSAI. Concurrent with this transaction, Wand Partners converted its $5.8 million of redeemable convertible preferred stock into common stock. The redeemable convertible preferred stock originally accrued and accumulated dividends at rates of seven to nine percent, compounded quarterly on the stated value per share and such dividends not paid in cash increased the stated value. The Company paid cash dividends totaling $69,046 in 1998 on the redeemable convertible preferred stock. Series B Convertible Preferred Stock is convertible into Common Stock of the Company at any time on a share-for-share basis. Series B Convertible Preferred Stock has the same rights with respect to voting and dividends as the Common Stock, except that each share of Series B Convertible Preferred Stock has the right to receive $1.00 in liquidation before any distribution is made to holders of the Common Stock. The liquidation value of Series B Preferred was $235,000 and $345,000 at December 31, 2000 and 1999, respectively. In May 1998, the Company offered Series B stockholders a 2% conversion premium payable in common stock for a share-for-share conversion of all shares held. The conversion offer, which expired on June 26, 1998, resulted in a premium of 19,200 common shares as 960,000 Series B shares were converted. The rights and benefits of remaining Series B stockholders are unchanged, including ongoing standard conversion rights. Series D Convertible Preferred Stock was convertible after January 1, 1996 at the option of the holder into one fully paid and non-assessable share of Common Stock of the Company on a share-for-share basis. The Company issued a redemption call in May 1998 for all of the outstanding Series D shares at a redemption price of $1.50 plus unpaid dividends payable as of June 30, 1998. Stockholders had the option of converting into common shares under the Preferred Shares Agreement and, as a result, 143,155 common shares were issued. After paying dividends of $17,941 on June 30, 1998, the Company reclassified the unconverted Series D balance to accrued expenses where approximately $36,000 remains unpaid at December 31, 2000 and 1999. NOTE 8 - OPTIONS AND WARRANTS: On April 1, 1984, the Company adopted an Incentive Stock Option Plan providing for the granting of options to purchase shares of the Company's common stock at a price equal to the market price of the stock at the date of grant. The Company's Stock Option Plan has authorized the grant of options to employees for up to 2,450,000 shares of the Company's common stock. Options generally vest over three years and are exercisable for five years from the date of grant. On May 6, 1997, the Company adopted the 1997 Stock Option Plan providing for the granting of options to purchase shares of the Company's common stock at a price equal to the market price of the stock at the date of grant. The 1997 Stock Option Plan has authorized the grant of options to employees for up to 1,000,000 shares of the Company's common stock. Options vest over three years and are exercisable for up to ten years from the date of grant, although most options currently outstanding expire five years from the date of grant. The Company has adopted the disclosure-only provisions of Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation ("FAS 123"). The Company will continue to account for its stock option plans in accordance with the provisions of APB 25, Accounting for Stock Issued to Employees. Accordingly, no compensation cost has been recognized in the financial statements for qualifying grants issued pursuant to the Company's Stock Option Plan. On October 23, 1998, the Company's Board of Directors approved a repricing of the Company's Stock Option Plan. The price of the new options was $.6875, the closing price on October 23, 1998. Options were exchanged at equal value using the Black-Scholes model and acceptance of the repricing offer was optional on the part of the employee. Employees surrendered 543,500 options for repricing and the Company granted 254,085 repriced options in accordance with this offer. The effect of this repricing is reflected in the tables below. The following table presents the activity of the Company's Stock Option Plan for the years ended December 31, 2000, 1999 and 1998:
Years Ended December 31, ------------------------------------------------------------------------------ 2000 1999 1998 ---- ---- ---- Weighted Weighted Weighted Av. Ex. Av. Ex. Av. Ex. Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Outstanding beginning of year 1,628,316 $1.20 1,579,124 $1.22 2,214,000 $1.58 Granted 270,500 .94 62,500 .72 454,124 .99 Exercised 79,122 1.08 -- -- 31,250 1.09 Canceled 714,873 .99 13,308 1.08 1,057,750 1.88 --------- --------- --------- Outstanding end of year 1,104,821 $1.28 1,628,316 $1.20 1,579,124 $1.22 ========= ========= ========= Options exercisable at year end 805,928 $1.42 1,322,786 $1.24 1,102,846 $1.22 ========= ========= ========= Weighted average fair value of options granted during the year $ 0.75 $ 0.42 $ 0.71 ========= ========= =========
The following table presents weighted average price and life information about significant option groups outstanding at December 31, 2000.
Options Outstanding Options Exercisable ------------------------------------------- --------------------------- Weighted Average Weighted Weighted Number Remaining Average Number Averaged Range of Outstanding Contractual Exercise Exercisable Exercisable Exercise Prices at 12/31/00 Life (Years) Price at 12/31/00 Price --------------- ----------- ------------ ----- ----------- ----- $ .31 15,000 3.00 $0.31 7,500 $0.31 $ .69 - $ .94 582,571 3.26 0.74 324,428 0.73 $1.38 - $1.94 283,750 2.01 1.54 274,000 1.55 $2.09 - $2.32 138,000 4.05 2.26 136,625 2.26 $2.50 - $2.91 85,500 5.08 2.69 63,375 2.75 --------- ---- ---- --------- ----- 1,104,821 3.18 $1.28 805,928 $1.42 ========= ==== ===== ========= =====
The following are the pro forma net loss and net loss per share for the years ended December 31, 2000, 1999 and 1998, as if the compensation cost for the option had been determined based on the fair value at the grant date for grants in those periods and reflected in the financial statements: Years Ended December 31, --------------------------------------------- 2000 1999 1998 ---- ---- ---- Net loss: As Reported $(2,994,574) $ (836,824) $(5,263,153) Pro Forma $(2,573,487) $(1,022,488) $(4,710,218) Net loss per share: As Reported $ (0.17) $ (0.05) $ (0.36) Pro Forma $ (0.14) $ (0.06) $ (0.32) The effects on the years ended December 31, 2000, 1999 and 1998 pro forma loss per share of expensing the estimated fair value of stock options are not necessarily representative of the effects on reporting the results of operations for future years because additional options will vest subsequent to December 31, 2000 and the Company expects to grant additional options in future years. The fair value of each option grant was estimated using the Black-Scholes model with risk-free interest rates on the date of grant, which ranged from 4.3% to 6.8%. The Company has never declared nor paid dividends on its common stock and does not expect to in the foreseeable future. The volatility factor of the expected market price of the Company's common stock used in estimating the fair value of the grants was 1.009 and the expected life of the options was estimated as five years. The Company, at the discretion of the Board of Directors, has granted warrants from time to time, generally in conjunction with the sale of equities. The following table presents warrants outstanding: December 31, ------------------------------------ 2000 1999 1998 ---- ---- ---- Eligible, end of year for exercise currently 4,999,040 5,000,580 5,000,580 ========= ========= ========= Warrants issued -- -- 2,500,000 Low exercise price $ -- $ -- $ 3.00 High exercise price $ -- $ -- $ 3.00 The warrants outstanding as of December 31, 2000 are currently exercisable and expire at various dates through October 5, 2005. The outstanding warrants entitle the owner to purchase one share of common stock for each warrant, at prices ranging from $0.65 to $3.00 per share; however, upon completion of the transactions contemplated by the merger agreement and the secured note agreement (Note 16), the current exercise price will be reduced in accordance with the terms and conditions of the warrant. During the year ended June 30, 1996, the exercise price of 1,000,000 warrants issued in the prior year was reduced from $1.50 to $.65. The maximum cumulative expense to be recorded by the Company upon exercise of these warrants will be $850,000. During the period ended December 31, 1996, the Company began recording, on a prorated basis, the maximum expense over the remaining life of the warrants. Accordingly, the Company recognized expenses totaling $106,000 annually in 2000, 1999 and 1998. NOTE 9 - SEGMENT INFORMATION: A. Description of reportable segments In prior years, the Company had three reportable segments. During 1998, the Internet segment ceased operations, and in 1999, 58.1% of the Traffic Systems segment was sold, leaving Financial Solutions as the sole reportable segment at December 31, 1999. Segment information for 1999 and 2000 has been omitted since all operations relate to a single segment. The Financial Solutions division produces and sells credit and debit card fraud detection products and database marketing products to financial institutions and processors of financial data. The Traffic Systems segment provided remote traffic management products, mainly to municipalities and universities. The Company's Internet segment was engaged in the development of an internet commerce solution. B. Measurement of segment profit or loss and segment assets The Company evaluates performance based on profit or loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in Note 1. C. Segment profit or loss and segment assets All revenues are from external customers. There are no intercompany sales. The "All Other" category represents general corporate activity.
Financial Traffic All Solutions Systems Internet Other Totals --------- ------- -------- ----- ------ Year Ended Dec. 31, 1998: Revenues $ 1,931,000 $ 235,000 $ 44,000 $ 31,000 $ 2,241,000 Depreciation and amortization expense 548,000 25,000 309,000 23,000 905,000 Segment profit (loss) (1,954,000) (1,933,000) (1,383,000) 7,000 (5,263,000) Segment assets 788,000 318,000 46,000 1,440,000 2,592,000 Expenditures for long-lived assets 29,000 37,000 8,000 58,000 132,000
D. Geographic Information Revenues are attributed to countries based on the location of customers. All long-lived assets are located in the United States. Years Ended December 31, ---------------------------------------- 2000 1999 1998 ---- ---- ---- United States $2,841,558 $4,196,612 $1,918,951 Belgium 276,799 151,200 212,097 Germany -- -- 17,460 Japan 117,532 685,850 55,333 Canada 416,533 81,117 27,000 Singapore -- -- 10,535 ---------- ---------- ---------- $3,652,422 $5,114,779 $2,241,376 ========== ========== ========== E. Revenues from Major Customers All revenues presented are derived from the Company's Financial Solutions segment with the exception of Customer E, which relates to the Traffic Systems segment. Customer A is a subsidiary of TSAI (see Notes 6, 7, 13, 15 and 16). Years Ended December 31, -------------------------------------- 2000 1999 1998 ---- ---- ---- Customer A $2,299,208 $3,106,631 $620,732 Customer B 285,834 -- -- Customer C -- 685,850 -- Customer D -- -- 445,115 Customer E -- -- 302,979 Customer F 276,799 -- -- Customer G 256,876 -- -- NOTE 10 - OTHER EXPENSE - NET: Other income (expense) as reflected in the consolidated statements of operations consists of the following: Years Ended December 31, --------------------------------------- 2000 1999 1998 ---- ---- ---- Interest income (expense) $ (192) $ 9,098 $ (20,350) Expense relating to financing operations (106,483) (106,484) (106,483) Other - net -- -- 100,655 ---------- --------- --------- Other expense - net $(106,675) $ (97,386) $ (26,178) ========= ========= ========= NOTE 11 - INCOME TAXES: The Company accounts for income taxes using the deferred liability method as required by Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes ("FAS 109"). Under FAS 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and the tax basis of assets and liabilities, and are measured using the enacted rates and laws that will be in effect when the differences are expected to reverse. Due to operating losses throughout the reporting periods, no provision for income taxes was made in 2000, 1999 or 1998. Significant components of the Company's deferred tax liabilities and assets as of December 31, 2000 and 1999 are as follows: December 31, ----------------------------- 2000 1999 ---- ---- Deferred tax liabilities: ------------------------- Property and equipment $ 3,000 $ -- Deferred development costs 13,000 22,000 ----------- ----------- Total deferred tax liabilities 16,000 22,000 Deferred tax assets: -------------------- Accounts receivable 2,000 2,000 Accrued expenses 347,000 308,000 Deferred income 35,000 32,000 Tax credits 17,000 17,000 Net operating loss 6,839,000 5,988,000 ----------- ----------- Total deferred tax assets 7,240,000 6,347,000 Valuation allowance (7,224,000) (6,325,000) ----------- ----------- Net deferred tax assets 16,000 22,000 ----------- ----------- Net deferred tax balance $ -- $ -- =========== =========== In accordance with FAS 109, a valuation allowance must be established until it is more likely than not that future benefits arising from net deferred tax assets will be realized. Realization is not assured in future tax projections. A reconciliation of the provision for income taxes to the amount computed using the Federal statutory tax rates consists of the following: Years Ended December 31, ------------------------------------------- 2000 1999 1998 ---- ---- ---- Income (loss) before taxes and investment loss $(1,655,000) $ 645,000 $(5,263,000) =========== ========= =========== Tax at statutory rate of 34% $ (563,000) $ 219,000 $(1,789,000) State income tax (net of federal benefit) (110,000) 47,000 (313,000) Effect of permanent differences (54,000) 36,000 101,000 Valuation allowance 727,000 (302,000) 2,001,000 ------------ ---------- ----------- Income tax expense $ -- $ -- $ -- ============ ========== =========== The Company has available at December 31, 2000, $18,399,000 and $9,829,000 of net operating loss carryforwards for federal and state purposes, respectively. These loss carryforwards may be applied against future taxable income and begin to expire in 2001. NOTE 12 - NESTOR TRAFFIC SYSTEMS, INC. AFFILIATE: On March 25, 1999, Nestor Traffic Systems, Inc., a subsidiary of the Company, sold a 37.5% common stock interest (540,000 shares at $4.35 per share) to a private group of investors for $2,350,000 in cash and issued an option to purchase an additional 17.5% of its common stock for $1,750,000. The option was scheduled to expire on January 31, 2000. On November 30, 1999, the Company, NTS and the investor group agreed to accelerate the exercise of the option and an additional 20.6% interest (710,000 shares at $2.47 per share) was sold for $1,755,000. On June 23, 2000, NTS sold additional shares of its common stock to private investors for $2,025,000 (450,000 shares at $4.50 per share). The investor group includes three officers and a director of the Company and the subsidiary, who in the aggregate, have contributed $970,085 of cash invested on the same basis as third-party investors. As discussed in Note 16, in January 2001, an agreement in principle was reached to combine the Company and NTS by merging NTS into a wholly-owned subsidiary of the Company with Nestor, Inc., in effect, becoming the surviving entity. As a result of the 1999 transactions, the Company's interest in NTS decreased to 41.9%, prompting the change from consolidation to equity accounting for the year ended December 31, 1999. The Company owns 34.62% of NTS at December 31, 2000. The investment in affiliate balances of $81,100 and $710,690 at December 31, 2000 and 1999, respectively, reflect the Company's interest in NTS's equity. Presented below is summarized NTS financial information at December 31, 2000 and 1999 and for the years then ended: December 31, ------------------------------ 2000 1999 ---- ---- Current assets $ 466,000 $2,124,000 Noncurrent assets 694,000 298,000 Current liabilities 925,000 724,000 Stockholders' equity 234,000 1,698,000 Total revenues 873,000 167,000 Operating expenses 4,425,000 2,656,000 Net loss 3,513,000 2,453,000 During the period January 1, 1999 through March 31, 1999, the Company advanced NTS financing to cover operating expenses amounting to approximately $550,000. Of this advance, $275,000 was reimbursed in March 1999, and the balance was paid in January 2001. Periodically, other advances are made by the Company to NTS primarily as a result of shared accounts. These amounts are due as invoiced and are also included in the due from affiliate balance. The amount due from NTS at December 31, 2000 and 1999 was $322,952 and $320,459, respectively. On January 1, 1999, the Company entered into an exclusive license with NTS to apply certain proprietary technologies in the fields of using video and other sensors to analyze, monitor and respond to movement of persons or objects in vehicular, rail, air or other modes of transportation or supporting the foregoing. The license expires upon the expiration of the underlying patents protecting the technologies used in NTS's products. The license provides for royalties to the Company starting in 2000 equal to 5% of the gross margin realized from sales or licensing of products subject to the license, and increasing to 10% of the gross margin in calendar years 2001 and beyond. The license requires minimum annual royalties of $125,000 beginning in 2001, increasing to $1,000,000 in 2005 and beyond, in order to maintain exclusive rights. This license will be extinguished upon effectiveness of the merger discussed in Note 16. The Company recorded royalties of $9,548 for 2000 and such amount is included in due from affiliate at December 31, 2000. No royalties were due or payable in 1999. NTS uses facility and administrative services of the Company, including office space and executive, accounting and other support personnel. NTS reimburses the Company monthly for these services at a rate of $39,913 for up to 15 NTS employees, and $47,267 for above 15 employees. Such reimbursement will decrease as NTS moves into its own office space and develops an independent executive and support staff. Facility and administrative fees charged to NTS were $567,000 in 2000 and $479,000 in 1999. Included in the due from affiliate balance at December 31, 2000 is $47,267 for December 2000 fees. NOTE 13 - RELATED PARTY TRANSACTIONS: Herbert S. Meeker, a director of the Company, is a partner in the law firm of Baer, Marks & Upham, which the Company uses for legal services. For the years ended December 31, 2000, 1999 and 1998, the Company recorded an expense for Baer, Marks & Upham of $4,874, $15,600 and $15,600, respectively. Bruce W. Schnitzer, who became a director of the Company in August 1994, is Chairman of Wand Partners, Inc., a private investment firm that the Company uses for management consulting. For the years ended December 31, 2000, 1999 and 1998, the Company recorded an expense for Wand Partners, Inc. of $43,048, $41,497 and $47,770, respectively. During 1998, the Company paid Wand Partners dividends totaling $69,046 on the redeemable preferred stock held by Wand. Included in accrued liabilities at December 31, 2000, 1999 and 1998 are $141,243, $99,167 and $63,738, respectively, due Wand Partners, Inc. Thomas D. Halket, who became an officer of the Company in January 1993, was a partner in the law firm of Hughes Hubbard & Reed LLP, which the Company used as outside counsel. For the years ended December 31, 2000, 1999 and 1998, the Company recorded an expense for Hughes Hubbard & Reed LLP of $35,852, $76,106 and $80,039, respectively. During 1998, TSAI, the parent company of Applied Communications, Inc. (ACI), became a significant shareholder of the Company (Note 7). Thomas H. Boje, Vice President, Corporate Development of TSAI, became a director of the Company in April 2000. For the years ended December 31, 2000, 1999 and 1998, the Company recorded revenues of $2,299,208, $3,106,631 and $620,730, respectively from ACI. At December 31, 2000 and 1999, accounts receivable included $639,013 and $489,494 due from ACI and unbilled were $3,184,924 and $3,141,574. Also at December 31, 2000 and 1999, deferred income included $3,192,849 and $2,904,634 from ACI. Further related party transactions with TSAI and ACI are discussed in Notes 6, 7, 8, 15 and 16. See Note 12 for transactions with affiliate. NOTE 14 - COMMITMENTS AND CONTINGENCIES: The Company maintains a facility in Rhode Island under an operating lease dated April 1, 1998, as amended. This lease provides for annual rentals of $195,000 through March 2001, $201,500 through March 2002, and $208,000 through March 2003. Rent expense of $195,000, $195,000 and $193,953 was charged to operations for the years ended December 31, 2000, 1999 and 1998, respectively. During 2000, The Company began leasing computer equipment under an operating lease agreement. The lease provides for monthly rent payments in arrears over a three-year term. At the end of the lease term, the Company may purchase the equipment at fair market value, extend the lease term or return the equipment. The value of leased equipment was $97,035 at December 31, 2000 and rent expense was $33,233 for the year. On August 1, 1994, the Company signed a Financial Advisory Agreement with Wand Partners, Inc. The terms of the Agreement specify that Wand Partners, Inc. will provide consulting services for a fee of $40,000 per year, plus out-of-pocket expenses. The Agreement is in effect so long as Wand Partners, Inc. owns at least 500,000 shares of Nestor's Common Stock, or other equities which are convertible into that number of shares of Common Stock (See Note 13 - Related party transactions). The aggregate minimum payments due over the remaining term of the above agreements are as follows: December 31, 2001 $ 280,000 December 31, 2002 287,000 December 31, 2003 106,000 December 31, 2004 40,000 December 31, 2005 40,000 Thereafter 40,000 --------- $ 793,000 ========= NOTE 15- LITIGATION: On October 6, 1998, HNC Software Corp. ("HNC"), a significant competitor of the Company's in the field of Financial Services, obtained a patent titled "Fraud Detection Using Predictive Modeling" and began advising prospective customers of the Company of the patent. Upon review of the patent and consideration of prior actions taken by HNC, the Company initiated a lawsuit against HNC in the United States District Court in Providence, RI on November 25, 1998 alleging violation of Sections 1 and 2 of the Sherman Act (antitrust), violation of the Rhode Island Antitrust Act, patent invalidity, and infringement of Nestor's patents (infringement claims withdrawn January 10, 2000). On June 15, 1999, HNC answered the lawsuit denying the allegations, bringing a counterclaim alleging infringement of the above described patent by the Company, and seeking a declaration of invalidity and unenforceability of one of the Company's patents. On the same day, HNC brought suit in San Diego, CA against ACI and its parent alleging various causes of action including patent infringement of the above described patent by the Company's PRISM product which ACI markets. In April 2000, HNC, ACI and its parent agreed to dismiss the lawsuit. ACI has requested that the Company provide indemnification for approximately $900,000 of its legal counsel costs pursuant the PRISM license agreement between ACI and the Company. The Company is disputing the indemnification claim and therefore, no accrual has been established. The Company and HNC reached a mutually agreeable settlement on January 16, 2001, the terms of which are confidential. All claims have been dismissed. Costs associated with the suit have been expensed as incurred. NOTE 16- SUBSEQUENT EVENTS: A. MERGER AND SECURED NOTE AGREEMENT In January 2001, an agreement in principle was reached to combine the Company and Nestor Traffic Systems, Inc., by merging NTS into a wholly-owned subsidiary of the Company, with Nestor, Inc. in effect becoming the surviving entity. The combination is subject to certain conditions including a fairness opinion of the transaction by a qualified investment company and approval by the shareholders of both companies. On January 9, 2001, the Company and NTS entered into a secured note agreement with NTS Investors, LLC (an independent investment group ("Group")). The Group loaned NTS $4,000,000 as of February 1, 2001 with principal and interest at 8% due on December 31, 2001. The note contains various covenants including restrictions on the use of proceeds and payments to Nestor, Inc. It is secured by NTS assets. Upon consummation of the combination contemplated above, the Group will convert the note to equity and increase its total investment to $8,000,000 in exchange for approximately 16,756,000 shares (33.34%) of Nestor, Inc. common stock, the current NTS shareholders will receive approximately 15,580,000 shares (31%) of Nestor, Inc. common stock and current Nestor, Inc. shareholders would then own approximately 17,922,000 shares (35.66%). If the combination is not consummated on or before December 31, 2001, the Group may elect on or before January 31, 2002 to convert the note into NTS common stock for up to a 25% fully diluted equity interest and reacquire up to an additional 25% fully diluted equity interest in NTS for an additional $4,000,000. In the event that the combination is completed, the Group will receive the right to acquire additional common stock at the same price at which warrants of Nestor, Inc. are exercised so as to maintain their ownership interest percentage. In addition, the Group will receive the option to acquire up to 1,000,000 shares of the Company's common stock at $1.28 per share for three years as dilution protection against both the Company's and NTS's converted employee stock options outstanding. B. NEW ACI LICENSE AGREEMENT On February 1, 2001, the Company entered into a license agreement with ACI pursuant to which ACI was granted a worldwide, perpetual, non-revocable, non-transferable and non-exclusive license in the field of use of fraud detection (including money laundering detection) in electronic payments. ACI may brand, customize, and extend the software products covered by the license agreement as well as use the software programs as a development platform to develop new functional and new end-user products or applications subject to the terms and conditions of the license. In return, ACI is fully responsible and liable for the provision of services to its licensees. Nestor, Inc. had previously provided support, maintenance and enhancements for these products. ACI has agreed to pay initial and guaranteed minimum license fees during the first year in the aggregate of $1,576,650 and, in addition, an ongoing license fee of 15% for source code license rights to the software products. The license granted to ACI is for products that presently constitute a substantial portion of the Company's gross revenues. During 2000, the Company recorded license fees of $1,401,305 under the previous 40% royalty rate and $897,903 of engineeirng revenues at normal full-fee rates (Note 13). Future ACI revenues are expected to decrease significantly due to the decrease in the royalty rate from 40% to 15% and the elimination of ACI engineering revenues. Future expenses relating to these revenues will also decrease because ACI has hired twelve employees from Nestor, Inc., effective February 1, 2001 and is reimbursing the Company $13,000 per month for up to six months for the continued use of Nestor, Inc. facilities and equipment prior to their office relocation. This agreement replaces the April 28, 1998 license agreement with ACI. EX-21 2 exhibit_ntsa.txt Exhibit 21.2 FINANCIAL STATEMENTS NESTOR TRAFFIC SYSTEMS, INC. (A Development Stage Company) December 31, 2000 NESTOR TRAFFIC SYSTEMS, INC. (A Development Stage Company) CONTENTS Page No. -------- Independent Auditor's Report 3 Balance Sheets - December 31, 2000 and 1999 4 Statements of Operations - For the Years Ended December 31, 2000 and 1999 5 Statements of Stockholders' Equity - For the Years Ended December 31, 2000 and 1999 6 Statements of Cash Flows - For the Years Ended December 31, 2000 and 1999 7 Notes to Financial Statements 8 Report of Independent Auditors The Board of Directors and Stockholders of Nestor Traffic Systems, Inc. We have audited the accompanying balance sheets of Nestor Traffic Systems, Inc. (a development stage company) as of December 31, 2000 and 1999, and the related statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 2000 and 1999 financial statements referred to above present fairly, in all material respects, the financial position of Nestor Traffic Systems, Inc. at December 31, 2000 and 1999, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States. The accompanying financial statements have been prepared assuming that Nestor Traffic Systems, Inc. will continue as a going concern. As discussed in Note 1, the Company is a development stage company that since inception has expended cash in excess of cash generated from operations. Additionally, the Company has a working capital deficit and has not achieved sufficient revenues to support future operations without additional financing. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are discussed in Note 11. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. ERNST & YOUNG LLP Providence, Rhode Island February 26, 2001 NESTOR TRAFFIC SYSTEMS, INC. (A Development Stage Company) Balance Sheets ASSETS December 31, ---------------------------- 2000 1999 ---- ---- CURRENT ASSETS: Cash and cash equivalents $ 54,690 $ 1,599,112 Accounts receivable 57,592 30,756 Unbilled contract revenue 109,673 20,000 Inventory 158,691 442,493 Other current assets 85,273 31,561 ----------- ----------- Total current assets 465,919 2,123,922 Investment in leased equipment - net of accumulated depreciation 487,031 138,961 Property and equipment at cost - net of accumulated depreciation 161,321 156,997 Other assets 45,320 1,680 ----------- ----------- TOTAL ASSETS $ 1,159,591 $ 2,421,560 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 593,383 $ 394,324 Due to affiliate 322,952 320,459 Deferred income 8,998 8,998 ----------- ----------- Total current liabilities 925,333 723,781 Commitments and contingencies -- -- STOCKHOLDERS' EQUITY: Common stock, $.01 par value, authorized 4,000,000 shares; issued and outstanding 2,600,000 shares at December 31, 2000 and 2,150,000 shares at December 31, 1999 26,000 21,500 Additional paid-in capital 9,599,371 7,554,446 Deficit accumulated during the development stage (9,391,113) (5,878,167) ----------- ----------- Total stockholders' equity 234,258 1,697,779 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,159,591 $ 2,421,560 =========== =========== The Notes to the Financial Statements are an integral part of this statement. NESTOR TRAFFIC SYSTEMS, INC. (A Development Stage Company) Statements of Operations
(Unaudited) Cumulative January 1, 1997 to Years Ended December 31, December 31, 2000 --------------------------------- ------------------ 2000 1999 ----- ---- Revenue: Lease and service fees $ 79,295 $ 18,474 $ 107,030 Product sales and engineering services 793,856 148,959 1,496,576 ------------ ------------ ------------ Total revenue 873,151 167,433 1,603,606 ------------ ------------ ------------ Operating Expenses: Engineering services 1,691,489 675,315 2,899,341 Product costs 681,742 36,644 862,589 Research and development 714,812 905,880 3,066,922 Selling and marketing 695,943 717,004 2,463,036 General and administrative 640,926 321,456 1,777,949 ------------ ------------ ------------ Total operating expenses 4,424,912 2,656,299 11,069,837 ------------ ------------ ------------ Loss from operations (3,551,761) (2,488,866) (9,466,231) Other income - net 38,815 36,333 75,118 ------------ ------------ ------------ Loss before income taxes (3,512,946) (2,452,533) (9,391,113) Income taxes -- -- -- ------------ ------------ ------------ Net Loss $ (3,512,946) $ (2,452,533) $ (9,391,113) ============ ============ ============ The Notes to the Financial Statements are an integral part of this statement.
Nestor Traffic Systems, Inc. (A Development Stage Company) Statements of Stockholders' Equity
Deficit Accumulated Common Stock During (the) ---------------------- Additional Development Shares Amount Paid-in Capital Stage Total ------ ------ --------------- ----- ----- Issuance of Common Stock 1,000 $ 1 $ 1,009 $ -- $ 1,010 Capital contributed by Nestor, Inc. -- -- 1,565,780 -- 1,565,780 Loss for the year ended December 31, 1997 -- -- -- (1,491,701) (1,491,701) ---------- ------- ---------- ----------- ----------- Balance at December 31, 1997 (unaudited) 1,000 $ 1 $1,566,789 $(1,491,701) $ 75,089 Capital contributed by Nestor, Inc. -- -- 1,904,156 -- 1,904,156 Loss for the year ended December 31, 1998 -- -- -- (1,933,933) (1,933,933) ---------- ------- ---------- ----------- ----------- Balance at December 31, 1998 (unaudited) 1,000 $ 1 $3,470,945 $(3,425,634) $ 45,312 Issuance of Common Stock 2,149,000 21,499 4,083,501 -- 4,105,000 Loss for the year ended December 31, 1999 -- -- -- (2,452,533) (2,452,533) ---------- ------- ---------- ----------- ----------- Balance at December 31, 1999 2,150,000 $21,500 $7,554,446 $(5,878,167) $ 1,697,779 Issuance of Common Stock 450,000 4,500 2,020,325 -- 2,024,825 Issuance of Warrants -- -- 24,600 -- 24,600 Loss for the year ended December 31, 2000 -- -- -- (3,512,946) (3,512,946) ---------- ------- ---------- ----------- ----------- Balance at December 31, 2000 2,600,000 $26,000 $9,599,371 $(9,391,113) $ 234,258 ========== ======= ========== =========== =========== The Notes to the Financial Statements are an integral part of this statement.
NESTOR TRAFFIC SYSTEMS, INC. (A Development Stage Company) Statements of Cash Flows
(Unaudited) Cumulative January 1, 1997 to Years Ended December 31, December 31, 2000 --------------------------------- ------------------ 2000 1999 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(3,512,946) $(2,452,533) $(9,391,113) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 102,509 51,033 197,372 Changes in assets and liabilities: Accounts receivable (26,836) (30,756) (57,592) Unbilled contract revenue (89,673) (11,659) (107,722) Inventory 283,803 (210,880) (39,232) Other assets (72,752) (19,186) (101,868) Accounts payable and accrued expenses 199,059 121,939 469,614 Deferred income -- 8,998 8,998 ----------- ----------- ----------- Net cash used by operating activities (3,116,836) (2,543,044) (9,021,543) ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (66,333) (140,967) (257,944) Investment in leased equipment (388,571) (142,336) (530,907) ----------- ----------- ----------- Net cash used by investing activities (454,904) (283,303) (788,851) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Due to affiliate 2,493 320,459 322,952 Capital investsments by affiliate - net -- -- 3,412,307 Proceeds from issuance of common stock - net 2,024,825 4,105,000 6,129,825 ----------- ----------- ----------- Net cash provided by financing activities 2,027,318 4,425,459 9,865,084 ----------- ----------- ----------- Net change in cash and cash equivalents (1,544,422) 1,599,112 54,690 Cash and cash equivalents - beginning of period 1,599,112 -- -- ----------- ----------- ----------- Cash and cash equivalents - end of period $ 54,690 $ 1,599,112 $ 54,690 =========== =========== =========== SUPPLEMENTAL CASH FLOWS INFORMATION: Interest paid $ 51 $ -- $ 51 =========== =========== =========== Income taxes paid $ -- $ -- $ -- =========== =========== =========== Non-cash transaction: Net assets transferred from affiliate $ -- $ -- $ 58,639 =========== =========== =========== The Notes to the Financial Statements are an integral part of this statement.
NOTES TO THE FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: A. ORGANIZATION Nestor Traffic Systems, Inc. (the "Company") was organized on January 1, 1997 in Delaware as a wholly-owned subsidiary of Nestor, Inc. to exploit and develop certain patent rights and know-how, which the Company licenses from Nestor, Inc. During 1999, the Company issued common stock to a group of private investors in two separate transactions aggregating $4,105,000, representing a 58.1% equity ownership in the Company. In June 2000, the Company sold additional shares of its common stock to private investors for $2,025,000, bringing their equity ownership to 65.38%. Nestor, Inc. owns the remaining 34.62% equity of the Company and accounts for the investment using equity accounting. As discussed in Note 11, in January 2001, an agreement in principle was reached to combine the Company into a Nestor, Inc. subsidiary, with Nestor, Inc. owning 100% of the Company post-merger. The Company's principal office is located in Providence, RI, and it maintains a branch office in Irvine, CA. The Company is a development stage company and has had limited revenues. Activities through December 31, 2000 consist primarily of raising capital, research and development, establishing supplies and production processes, and sales and marketing. The financial statements have been prepared on a going-concern basis. From its inception through December 31, 2000, the Company has expended cash in excess of cash generated from operations. Additionally, the Company has a working capital deficit and has not achieved sufficient revenues to support future operations without additional financing. Management is in the process of identifying new customers and raising additional capital to support its operations and provide sufficient liquidity to enable it to continue as a going concern (Note 11). These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. B. CASH EQUIVALENTS The Company considers all highly liquid debt instruments purchased with an original maturity of 90 days or less to be cash equivalents. C. DEPRECIATION Depreciable assets are recorded at cost. Depreciation is provided on the straight-line method over the estimated useful lives or lease term of the respective assets. Maintenance and repairs are expensed as incurred. Major renewals and betterments are capitalized. D. REVENUE RECOGNITION Revenue is derived mainly from the sale or lease of products which incorporate the Company's software and the delivery of services based upon such products. Lease and service fees include software license and processing service fees tied to citations issued to red-light violators. The Company provides equipment, in some instances under operating lease agreements, and engineering services ranging from installation, training, and basic consulting to software modification and customization to meet specific customer needs. Postcontract customer support includes maintenance agreements. In software arrangements that include multiple elements, the Company allocates the total arrangement fee among each deliverable based on the relative fair value of each of the deliverables determined based on vendor-specific objective evidence. Revenue has been recognized as follows: Product Sales - The Company recognizes the revenue allocable to product sales upon delivery of the product to the end user, unless the fee is not fixed or determinable or collectibility is not probable. The Company considers all arrangements with payment terms extending beyond twelve months and other arrangements with payment terms longer than normal not to be fixed or determinable. In most situations, the Company considers its acceptance terms as perfunctory. Arrangements that include acceptance terms that are not considered perfunctory are not recognized until acceptance has occurred. If collectibility is not considered probable, revenue is recognized when the fee is collected. Revenue on arrangements with customers who are not the ultimate users (distributors, other resellers, etc.) is not recognized until the software is delivered to an end user. Product returns or exchanges are charged to operations as incurred. 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 the Company'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 related tickets. Contract Accounting - For arrangemetns 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. Certain contracts include penalty provisions relating to timely performance and delivery. Penalties are charged to operations as incurred. Postcontract Customer Support - Revenue is recognized on a straight-line basis over the period provided. Training revenue is recognized upon the completion of training sessions with the customer. E. CONCENTRATIONS OF CREDIT RISK The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable. The Company places its cash and temporary cash investments with high credit quality institutions. At times such investments may be in excess of the FDIC insurance limit. The Company routinely assesses the financial strength of its customers and, as a result, believes that its trade accounts receivable credit risk exposure is limited. The Company does not require collateral from its customers. Management believes the allowance carried for doubtful accounts receivable is adequate to cover potential losses associated with uncollectible accounts receivable. F. INVENTORY Inventory is valued at the lower of cost or market on the first-in, first-out basis and consists of the following at December 31, 2000 and 1999: December 31, ----------------------------------------- 2000 1999 ---- ---- Work-in-progress $ 138,445 $ 325,171 Finished goods 20,246 117,322 --------------- ---------------- Total inventory $ 158,691 $ 442,493 =============== ================ G. ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. H. CHANGE IN PRESENTATION Certain December 31, 1999 amounts have been reclassified to conform to the December 31, 2000 presentation. NOTE 2 - INVESTMENT IN LEASED EQUIPMENT: In 1999, the Company entered into an operating lease with a customer providing for quarterly fixed payments of system lease and software license fees of $13,497 over a term of 36 months, and providing for a lump-sum buyout of $20,834 at the end of the term. Future minimum lease revenues are $53,988 in 2001 and $49,489 in 2002, totaling $103,477 over the remaining term of the lease. In addition, the agreement calls for software license and processing fees tied to citations issued to red light violators, which totaled $25,307 in 2000. At December 31, 2000, the Company has five contracts in process with anticipated acceptance under operating lease agreements having 36-month terms. Equipment and installation costs related to operating lease contracts are capitalized and, after acceptance, are depreciated over the minimum lease term of the related lease agreement, currently three years. Revenues realized from these agreements, generally in the form of per-citation fees, is expected to be adequate to cover the capitalized and future costs related to these agreements. December 31, ------------------------- 2000 1999 ---- ---- Equipment under operating leases: Work-in process $ 388,571 $ -- Installed and accepted 142,336 142,366 ---------- ---------- 530,907 142,336 Less: Accumulated depreciation (43,876) (3,375) ---------- ---------- Net investment in leased equipment $ 487,031 $ 138,961 ========== ========== NOTE 3 - PROPERTY AND EQUIPMENT AT COST-NET: December 31, --------------------- Useful Life 2000 1999 or Lease Term ---- ---- ------------- Computer equipment $ 231,284 $ 184,449 5 years Demonstration equipment 101,315 93,244 3 years Leasehold improvements 11,426 -- 5 years --------- --------- 344,025 277,693 Less: Accumulated depreciation (182,704) (120,696) --------- --------- $ 161,321 $ 156,997 ========= ========= NOTE 4 - DUE TO AFFILIATE: During the period January 1, 1999 through March 31, 1999, Nestor, Inc. advanced the Company financing to cover operating expenses amounting to approximately $550,000. Of this advance, $275,000 was reimbursed to Nestor, Inc. in March 1999, and the balance was paid in January 2001. Included in due to affiliate at December 31, 2000 is $9,548 representing royalties for 2000 and the December 2000 facility and administrative fee of $47,267 (Note 9). Periodically, other advances are made on behalf of the Company by Nestor, Inc., primarily as a result of shared accounts. These amounts are due and paid as invoiced and are also included in the due to affiliate balance. NOTE 5 - COMMON STOCK: On March 25, 1999, the Company sold a 37.5% common stock interest to a private group of investors for $2,350,000 in cash and issued an option to purchase an additional 17.5% of its common stock for $1,750,000. The option was scheduled to expire on January 31, 2000. On November 30, 1999, the Company and the investor group agreed to accelerate the exercise of the option and the investor group purchased an additional 20.6% ownership in the Company for $1,755,000. On June 23, 2000, the Company sold additional shares of its common stock to private investors for $2,025,000, bringing their equity ownership to 65.38%. The investor group includes three officers and a director of the Company who, in the aggregate, have contributed $970,085 of cash invested on the same basis as third-party investors. As discussed in Note 11, in January 2001, an agreement in principle was reached to combine the Company with a Nestor, Inc. subsidiary, with Nestor, Inc. acquiring a 100% equity interest in the Company in exchange for Nestor common stock. If the merger does not occur, new investors have the option of investing $8,000,000 in the Company for a 50% common equity position. NOTE 6 - OPTIONS: On May 5, 1999, the Company adopted the 1999 Stock Option Plan providing for the granting of options to purchase shares of the Company's common stock at a price equal to the fair market value of the common stock at the date of grant as determined by the Board of Directors. The 1999 Stock Option Plan has authorized the grant of options to employees for up to 400,000 shares of the Company's common stock. Options are exercisable for up to ten years from the date of grant. As discussed in Note 11, an agreement in principle was reached to combine the Company and Nestor, Inc., with Nestor, Inc. being the surviving entity. Options outstanding at the combination date are expected to be exchanged for comparable Nestor, Inc. options at the exchange ratio in effect on the combination date. The Company has adopted the disclosure-only provisions of Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation ("FAS 123"). The Company will continue to account for its stock option plan in accordance with the provisions of APB 25, Accounting for Stock Issued to Employees. Accordingly, no compensation cost has been recognized in the financial statements for qualifying grants issued pursuant to the Company's Stock Option Plan. The following table presents the activity of the Company's Stock Option Plan for the years ended December 31, 2000 and 1999:
2000 1999 ------------------------- ----------------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price ------ ----- ------ ----- Outstanding beginning of year 87,000 $5.00 -- $ -- Granted 109,000 5.00 90,000 5.00 Exercised -- -- -- -- Canceled 1,000 5.00 3,000 5.00 -------- -------- Outstanding end of year 195,000 $5.00 87,000 $5.00 ======== ======== Options exercisable at year end 56,200 $5.00 17,400 $5.00 ======== ======== Weighted average fair value of options granted during the year $ 1.87 $ 1.42 ======== ========
All options granted and outstanding have a ten-year life and vest 20% upon issuance and each anniversary thereafter, until fully vested. Below is the pro forma net loss for the years ended December 31, 2000 and 1999, as if the compensation cost for the option had been determined based on the fair value at the grant date: December 31, ------------------------------------- 2000 1999 ---- ---- Net Loss: As Reported $ (3,512,946) $ (2,452,533) Pro Forma $ (3,566,961) $ (2,468,730) The fair value of each option grant was estimated using the Minimum Value method with risk-free interest rates on the date of grant, which ranged from 5.3% to 6.8%. The Company has never declared nor paid dividends on its common stock and does not expect to in the foreseeable future. NOTE 7 - OTHER INCOME - NET: Other income as reflected in the statements of operations consists primarily of interest income realized on short-term investments. NOTE 8 - INCOME TAXES: The Company accounts for income taxes using the deferred liability method as required by Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes. Under FAS 109, deferred tax assets and liabilities are determined based on differences between financial reporting and the tax basis of assets and liabilities, and are measured using the enacted rates and laws that will be in effect when the differences are expected to reverse. Significant components of the Company's deferred tax liabilities and assets as of December 31, 2000 and 1999 are as follows: December 31 -------------------------------- 2000 1999 ---- ---- Deferred tax assets: ------------------- Accrued expenses $ 48,000 $ 25,000 Net operating loss 3,694,000 2,317,000 ------------ ------------ Total deferred tax assets 3,742,000 2,342,000 Valuation allowance (3,742,000) (2,342,000) ------------ ------------ Net deferred tax assets -- -- ------------ ------------ Net deferred tax balance $ -- $ -- ============ ============ In accordance with FAS 109, a valuation allowance must be established until it is more likely than not that future benefits arising from net deferred tax assets will be realized. Realization is not assured in future tax projections. A reconciliation of the provision for income taxes to the amount computed using the Federal statutory tax rates consists of the following: 2000 1999 ---- ---- Loss before taxes $ (3,513,000) $ (2,453,000) ============= ============= Tax at statutory rate of 34% $ (1,195,000) $ (834,000) State income tax (net of federal benefit) (208,000) (145,000) Effect of permanent differences 3,000 3,000 Valuation allowance 1,400,000 976,000 ------------- ------------- Income tax expense $ -- $ -- ============= ============= The Company has available at December 31, 2000, $9,248,000 of net operating loss carryforwards for federal and state purposes. These loss carryforwards may be applied against future taxable income and begin to expire in 2012 for federal purposes and 2002 for state purposes. The Company has had numerous equity transactions during its history. These transactions may affect the Company's ability to utilize these net operating loss carryforwards due to certain provisions contained in IRC Section 382. NOTE 9 - RELATED PARTY TRANSACTIONS: On January 1, 1999, the Company entered into an exclusive license with Nestor, Inc. to apply certain proprietary technologies in the fields of using video and other sensors to analyze, monitor and respond to movement of persons or objects in vehicular, rail, air or other modes of transportation or supporting the foregoing. The license expires upon the expiration of the underlying patents protecting the technologies used in the Company's products. The license provides for royalties to Nestor, Inc. starting in 2000 equal to 5% of the gross margin (revenues less third-party direct cost of sales) realized from sales or licensing of products subject to the license, and increasing to 10% of the gross margin in calendar years 2001 and beyond. The license requires minimum annual royalties of $125,000 beginning in 2001, increasing to $1,000,000 in 2005 and beyond, in order to maintain exclusive rights. The Company recorded royalties of $9,548 for 2000 and such amount is included in due to affiliate at December 31, 2000. No royalties were due or payable in 1999. The Company uses facility and administrative services of Nestor, Inc., including use of office space and executive, accounting and other support personnel. The Company reimburses Nestor, Inc. monthly for these services at a rate of $39,913 for up to 15 Company employees, and $47,267 for above 15 employees. These fees will be replaced with direct expenses as the Company moves into its own office space (Note 10) and develops an independent executive and support staff. Facility and administrative fees charged to the Company were $567,000 in 2000 and $479,000 in 1999. Included in due to affiliate at December 31, 2000 is $47,267 for December 2000 fees. NOTE 10 - COMMITMENTS AND CONTINGENCIES: The Company maintains a sales and support office in California under an operating lease dated July 1, 1999. This lease provides for monthly rentals of $650, and can be terminated upon 60 days advance notice. Total expense under the lease was $7,800 in 2000 and $3,900 in 1999. The Company entered into an operating lease dated June 21, 2000 for office and warehouse facilities in Rhode Island. This lease provides for monthly rentals of $10,360 for August 2000 through July 2003 and then increases to $10,800 monthly through July 2005. Rent expense for this lease was $51,800 in 2000. On October 14, 1999, the Company entered into an engagement letter with FAC Equities, a division of First Albany Corporation, to provide financial advisory and investment banking services to the Company relating to the potential sale of additional equity securities by the Company. The Company issued a warrant to FAC to purchase up to 10,000 shares of the company's common stock at $.01 per share (expires October 14, 2004) and recorded deferred financing costs of $24,600 associated with these warrants in 2000. While this agreement expired in July 2000 without closing an equity transaction, FAC is still entitled to a fee equal to 5% of the gross proceeds in cash plus a warrant equal to 3% of the common shares, or equivalents, sold in any transaction consumated prior to July 13, 2002 with an investor identified by FAC. NOTE 11 - SUBSEQUENT EVENTS: In January 2001, an agreement in principle was reached to combine the Company and Nestor, Inc., by merging the Company into a wholly-owned subsidiary of Nestor, Inc., with Nestor, Inc., in effect, being the surviving entity. The combination is subject to certain conditions including a fairness opinion of the transaction by a qualified investment company and approval by the shareholders of both companies. On January 9, 2001, the Company and Nestor, Inc. entered into a secured note agreement with NTS Investors, LLC (an independent investment group ("Group")). The Group loaned the Company $4,000,000 as of February 1, 2001 with principal and interest at 8% due on December 31, 2001. The note contains various covenants including restrictions on the use of proceeds and payments to Nestor, Inc. It is secured by the Company's assets. Upon consummation of the combination contemplated above, the Group will convert the note to equity and increase its total investment to $8,000,000 in exchange for approximately 16,756,000 shares (33.34%) of Nestor, Inc. common stock, the Company's current shareholders will receive approximately 15,580,000 shares (31%) of Nestor, Inc. common stock and current Nestor, Inc. shareholders would then own approximately 17,922,000 shares (35.66%). If the combination is not consummated on or before December 31, 2001, the Group may elect on or before January 31, 2002 to convert the note into the Company's common stock for up to a 25% fully diluted equity interest and reacquire of up to an additional 25% fully diluted equity interest for an additional $4,000,000. In the event that the combination is completed, the Group will receive the right to acquire additional common stock of Nestor, Inc. at the same price at which warrants of Nestor, Inc. are exercised so as to maintain their ownership interest percentage. In addition, the Group will receive the option to acquire up to 1,000,000 shares of Nestor common stock at $1.28 per share for three years as dilution protection against both Nestor Inc.'s and the Company's converted employee stock options outstanding. -----END PRIVACY-ENHANCED MESSAGE-----