-----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, L5VqQsHghFDbVlgjobKHwuytd/OVQyBB7KA8VbLv2uBs5kAnon/wd9ErE11++lLf v9SW0NihaoJgWvfe2zuQBg== 0000720851-99-000004.txt : 19990412 0000720851-99-000004.hdr.sgml : 19990412 ACCESSION NUMBER: 0000720851-99-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990409 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 SEC ACT: SEC FILE NUMBER: 000-12965 FILM NUMBER: 99590038 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 1 105 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended December 31, 1998 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: The aggregate market value of the voting stock held by non- affiliates of the registrant, based on the average bid and asked prices of such stock on March 12, 1999 was $5,412,000. The number of shares outstanding of the Registrant's Common Stock at March 12, 1999 was 17,499,327. DOCUMENTS INCORPORATED BY REFERENCE. Information to be included in registrant's definitive proxy or information statement to be filed with the Commission not later than 120 days following the end of registrant's fiscal year is incorporated by reference in Part III of the Form 10-K. ITEM 1. Business Prospective Statements The following discussion contains prospective statements regarding Nestor, Inc. and its subsidiaries ("Nestor" or "the Company"), its business, outlook and results of operations that are subject to certain risks and uncertainties and to events that could cause the Company's actual business, prospects and results of operations to differ materially from those that may be anticipated by, or inferred from, such prospective statements. Factors that may affect the Company's prospects include, without limitation:, the Company's ability to successfully develop new contracts for technology development; the impact of competition on the Company's revenues or market share; delays in the Company's introduction of new products; and failure by the Company to keep pace with emerging technologies. Readers are cautioned not to place undue reliance on these prospective statements, which speak only as of the date of this report. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's reports filed with the Securities and Exchange Commission. General Nestor, Inc. designs, develops, markets, and supports intelligent software solutions for mission-critical decision applications in real-time environments. Nestor employs proprietary neural network predictive models to convert existing data and business experiences into meaningful recommendations and actions. The Company has leveraged its neural-network software architecture across a wide range of markets, including financial-institution credit/debit card fraud, database marketing and real-time traffic- control systems. In addition, the Company believes that its technology and software architecture are well suited for intelligent decision applications addressing a variety of other markets, including health care payments and long distance and mobile phone fraud applications. Background The Company was incorporated under the laws of the State of Delaware on March 21, 1983, in order to exploit, develop and succeed to certain patent rights and know-how relating to the Nestor Learning System(Tm) ("NLS"), which the Company acquired in 1983 from its predecessor Nestor Associates, a limited partnership. NLS is an adaptive or self-organizing software system, commonly referred to as a neural network, that is capable of extracting the salient features of input patterns without being told what features to look for and of subsequently recognizing similar patterns identified by such features. Thus, NLS can be said to learn from its experience. On January 1, 1997, Nestor, Inc. formed two wholly-owned subsidiaries: Nestor Traffic Systems, Inc. (Traffic Systems), formerly Nestor Intelligent Sensors, Inc., and Nestor Interactive, Inc. (Interactive). Traffic Systems develops and markets the TrafficVision(R), CrossingGuard(R) and the Ni1000 product lines while Interactive developed InterSite, an internet commerce solution. Nestor offers complete application-software solutions that include adaptive decision models, implementation, education, training, consulting, processing and engineering support services. Current Nestor software products detect credit/debit card, merchant and other forms of fraud (PRISM(R)), provide remote traffic management of freeways (TrafficVision) and intersections (CrossingGuard), provide intelligent, organization- wide marketing campaign management (CampaignOne(TM)), provide responsive on-line information to internet Web site visitors (InterSite) and provide much greater efficiencies in document processing and fax distribution environments (NestorReader, OmniTools and N'Route, which were licensed to National Computer Systems in June 1996). Nestor's software solutions are designed for client-server implementation and flexible integration with customers' existing computing infrastructures. Installation time periods for the Company's software solutions depend upon the particular product involved, and can take as little as three days or as long as six months. The Company believes that PRISM customer payback periods for license, installation, and first year user fees are typically less than one year. The Company designs and develops specialized software products utilizing its proprietary software and information-management knowledge, and, to a lesser degree, designs hardware components that will enhance the performance of its software products. The Company's products comprise the following categories: Fraud Detection and Risk Assessment Systems - are designed to effectively detect and control fraudulent transactions for financial institutions that issue credit, debit, or other financial use cards. CampaignOne was introduced in 1998 to the financial services customers of the Company as a back-office marketing solution that can manage programs ranging from risk evaluation (bankruptcy) to marketing strategies. The Company is evaluating the expansion of these product technologies into additional applications such as health-care payments, long- distance telephone fraud and mobile-phone service theft. Traffic Management Systems - are a combination of internally developed software and internally and externally developed hardware components that perform as a traffic management system for open road and intersection applications. The products enable dual use of video networks to support both traffic/roadway data and surveillance. Internet Web Server Systems - are designed to synthesize information from multiple data sources within an organization and provide content to present to Web site visitors based on the current state of the visitor's information. Intersite's purpose is to provide scores of site visitors, which are useful in predicting the purchasing behavior of visitors. Intelligent Character Recognition Systems - include packages of software applications such as OmniTools, NestorReader, and N'Route which increase productivity in document processing and fax distribution environments. Fraud Detection and Risk-Assessment Systems The Company's PRISM product line includes the Nestor Fraud Detection System (FDS(TM)) and the flagship product, Proactive Risk Management (PRISM) system which have been licensed to twelve financial-services clients as of December 31, 1998. These systems can detect bank-card or credit-card fraud, and can be readily updated by clients to adapt to changing patterns of fraudulent transactions. By monitoring each cardholder's historical and current transactions, PRISM is capable of detecting unusual patterns of card use and of rapidly detecting a significant proportion of fraudulent transactions with an extremely low error rate. Customers have reported a reduction of more than 50% in their credit-card fraud loss experience within 30 days of installation. In March 1993, the Company completed the installation of its FDS product at Mellon Bank. The success of the FDS installation at Mellon has been instrumental in obtaining additional orders for FDS and PRISM. Like many other credit-card issuers, Mellon Bank had been using a rule-based system for fraud detection. Mellon has reported to the Company that FDS found 20 times as many instances of fraud as their rule-based system, while requiring reviews of only one-third as many accounts. In December 1994, the Company installed a merchant-fraud detection system at Europay International S.A., a Master Card affiliated association of 700 banks that settle international bank-card transactions involving currency exchange. Experience with United Kingdom and Belgium banks indicates a counterfeit detection rate of up to 50%. In February 1995, the Company announced PRISM. PRISM enhances the fraud-detection capabilities of FDS to include workflow management and other PC-based productivity tools that are designed to enable the fraud manager and fraud-control team to efficiently identify and track frauds detected by the system. The initial PRISM system was an upgrade to FDS installed at G.E. Capital Consumer Financial Services; the upgrade incorporated PRISM in 1995. During 1997, the Company expanded its PRISM product line with the introduction of PRISM Debit (Debit), PRISM Bankruptcy (Bankruptcy), and PRISM Credit (Credit). Debit is an intelligent risk management system that detects, monitors, responds to and prevents off-line debit card fraud. Bankruptcy is a bankruptcy decision-support system that provides transaction-level analysis of each account and enables card issuers to better manage risk while increasing portfolio profitability. Credit is a multi- faceted fraud detection system that dramatically reduces losses associated with credit and retail card application fraud. The following are the primary attributes of the Fraud Detection and Proactive Risk Management Systems: Flexible neural-network decision engine. The Company's software implements a powerful, patented neural-network technology for adaptive fraud detection that is accurate, fast, field-trainable and operates in real-time. The neural-network and rule-bases are provided through software that allows the Company's products to be customized to fit the customers needs and profiles without extensive custom programming. Unlike other rule-based systems, the Company's products learn from the experience of the specific customer accounts instead of applying "industry" experience to the customer's environment. The Company's software can be rapidly trained to look for customer-specific fraud potential by requiring as few as three training passes through a customer's data. The system automatically adapts itself for problem complexity and maximizes the detection of actual fraud while minimizing false positive indications. Automatic and ongoing learning ability. The Company's software is trained to detect fraudulent patterns based upon the customer's own historical data. Subsequent to installation, the software continues to update its records for current patterns and automatically modifies its predictive model to respond to fraud pattern changes in the customer's user base and environment. Other competitive systems may require extensive updating of the software to reflect current industry or customer experience. The Company's software allows the client to operate with the most current and customer-specific database possible, with simple updates entirely under client control. Quick return on initial investment to customers. Due in part to customizing the PRISM software to react based upon a client's specific fraud experience, the product has resulted in fraud loss savings of greater than 50% at G.E. Capital Consumer Financial Services and over 50% in counterfeit detection at Europay International S.A.. Performance at this level would provide a customer experiencing average industry fraud losses a payback on their first year installation and use fees of approximately four to six months. On-line, transaction-based capability. Nestor's software can provide an immediate, situation-specific response to each customer transaction. For example, the PRISM system can immediately detect and report fraudulent activity within the first one or two transactions, rather than within one or two days of transactions. Flexible client-server and operating solutions. Nestor's solutions can be integrated into a customer's existing environment or architecture. The Company's products are based upon a distributed client-server architecture consisting of operating components that operate on a wide range of industry standard, client-server platforms, including the IBM, MVS/CICS, Tandem's proprietary, fault tolerant Non Stop Kernel (NSK), UNIX and Windows NT operating platforms. PRISM also provides an analysis environment consisting of: a user-friendly, MS Windows- compatible graphical user interface, an "open-systems" architecture that is easily adapted to a client's working environment, fully integrated work flow tools for enhanced productivity, customizable reporting tools, and in-depth fraud analysis and system maintenance tools. Nestor's Fraud Detection and Risk Assessment Strategy The Company's objectives are: to deliver high quality products and services using proprietary neural-network technology to the banking, retail, telecommunications and health-care management industries, and to accrete a growing revenue stream from ongoing product usage fees. The Company's strategy for achieving these objectives includes the following key elements: Expand current distribution network. The Company plans to expand its worldwide direct sales, distribution and service forces. The Company intends to continue developing domestic markets while augmenting its international growth. Nestor executed a non- exclusive PRISM reseller agreement with CSK Corporation in Japan during 1996 (See "Licensing, Joint Venture and Development Agreements). The Company also intends to increase direct sales efforts in North America through expansion of direct sales staff and through marketing and service agreements with established providers of products and services to its target markets. On April 18, 1997, the Company expanded its non-exclusive license agreement with Applied Communications, Inc. (ACI), a subsidiary of Transaction Systems Architects, Inc., by allowing ACI to distribute the newly developed PRISM products and other products of the Company throughout its worldwide sales and support network. (See "Licensing, Joint Venture and Development Agreements".) Earn recurring revenues through on-going fees based upon product usage. The Company's products provide immediate and ongoing savings to the client through a reduction in the occurrence of undetected fraud losses. The Company has priced its product to include upfront fees for licensing and installation, thereby providing an attractive payback of the customer's initial investment as discussed above, and including an ongoing usage fee based upon the number of customer transactions or accounts being reviewed by the software. This ongoing revenue stream is expected to grow as new customers install the product. Future growth may also result from the customer's internal growth in the number of transactions or accounts being reviewed by the software. Apply PRISM products to other markets. The Company believes that many markets exist which are experiencing fraud type losses and possess data characteristics similar to the financial institution industry. The Company plans to extend the successes of the PRISM product in credit-card fraud detection to other areas with a high level of transactions and a history of similar fraud-type loss experience. Some of these market opportunities may include internet market fraud losses, health-care claim payments and long-distance telephone fraud. Nestor's strategy is to broaden its product offerings to address these markets in conjunction with development funding from strategic government and industry sources. Offer new products leveraging current services, customer knowledge and relationships. During 1998, the Company introduced CampaignOne, a comprehensive customer relationship and marketing campaign management solution designed to maximize the effectiveness and efficiency of marketing campaigns for all aspects of financial opportunity from: customer acquisition, retention cultivation and overall customer profitability. CampaignOne can be basic decision tree models delivered by the customer or utilize the Company's customized neural-network models. Traffic Management Systems TrafficVision and CrossingGuard products are a combination of Company-developed software and modular hardware components that provide for remote monitoring to support traffic data collection and control of traffic flows. The product is flexible and can be configured to a wide range of road configurations, including open roads and intersections. Features include remote video monitoring, real-time vehicle classification, individual vehicle tracking, simultaneous communication of video and traffic data over a single communication network, detection and enforcement of red-light violators, and generation and logging to a database of a variety of traffic-information measurements. Historically, traffic sensing and control has been handled by wire induction loops buried beneath the road surface. The system provides basic information such as vehicle counts and speed (with multiple loop configurations), in support of the function of controlling traffic light signals when traffic is present. Such loops experience nearly a 100% failure rate within the first 10 years of operation. Replacement/repair is often not performed or performed long after loop failure due to the high cost of digging up the roadway. TrafficVision provides all the benefits currently offered by loop systems and substantial additional options that increase the traffic controller's effectiveness in managing traffic congestion, infractions, and accidents. The fact that TrafficVision operates completely above ground aids in effective maintenance. CrossingGuard applies the TrafficVision technologies to make intersections safer and to enforce red-light running statues. Using video, the system predicts if a vehicle will or will not stop at an intersection before a yellow light turns red. If the system determines that a vehicle will not stop, the system records the violation for ticket issuance and sends a signal to the traffic light controller unit recommending a delay in the change of light to green for cross traffic. TrafficVision is designed to incorporate the Company's Ni1000 Recognition Accelerator(R) hardware chip (See "Ni1000 Chip" below). Development of a working TrafficVision prototype model commenced on September 1, 1995, in conjunction with a funding agreement with California Institute of Technology Jet Propulsion Laboratory (see "Licensing, Joint Venture, and Development Agreements"). The project was completed in December 1996. The Company began a Phase II contract for field testing of the prototype in 1997 and expects to complete this work in the second quarter of 1998. In February 1998, the Rhode Island Department of Transportation (RIDOT) formally opened its new Operations Center. As an integral part of that facility, TrafficVision is providing real- time traffic management capabilities which assist RIDOT in improving safety, monitoring traffic flow, managing congestion and planning for maximum highway efficiency. The first CrossingGuard application commenced in Vienna, Virginia in 1998 and is expected to be operational in April 1999. The following are the primary attributes of the Company's Traffic Management Systems: Accurate, real-time interpretation of traffic video images. The Company has leveraged its patented neural-network decision engine discussed above in Fraud Detection to the application of real- time processing and learning in the context of video image interpretation for traffic management and control. Prior industry attempts to provide video-based detection of traffic have not proven effective due to the difficulty of designing robust detection algorithms under a variety of illumination, visibility and traffic conditions, as well as the need to implement such algorithms on cost-effective computing platforms that provide real-time operation. The Company's neural-network technology, combined with its Ni1000 chip, discussed below, is able to interpret video images accurately and respond in a real- time environment. Rapid deployment and increased services for customers. The Company's software solutions are designed for rapid deployment and to provide additional information to customers beyond that delivered by current loop systems. TrafficVision and CrossingGuard are designed to be installed entirely above ground and to tie into existing customer hardware where appropriate. Maintenance becomes more efficient than with underground loop systems. These systems allow the customer to obtain the same information and accuracy as is available through loop technology (e.g. vehicle count and detection for signal control), and additional benefits such as remote real-time video monitoring for traffic flow, vehicle tracking, incidence response video-based red-light enforcement, and intersection safety. Leverages customer investment in video infrastructure. State traffic departments are deploying roadside video cameras to provide images of road and traffic conditions to better manage traffic flows and incident response. Nestor's Traffic Monitoring Systems are designed to support "dual use" of pan-tilt-zoom equipped cameras for surveillance and traffic detection and monitoring, thus leveraging the customer's investment in existing video equipment. Additionally, Nestor's solution supports simultaneous video and data communication over a single video communication network, thus further leveraging the customer's video infrastructure investment. Compatibility with industry standard platforms. Nestor's traffic monitoring solutions are architected around dominant industry- standard platforms: namely, the Windows 95/NT operating system, tools and communication support components and general "WinTel" hardware specifications. This facilitates integration into a customer's existing computing environment, leverages PC economics to offer a compelling price/performance advantage and lowers product engineering development costs. Additionally, the Company's Traffic Monitoring Systems are designed to support the emerging NTCIP communications standards being mandated in the traffic detector industry. Further, roadside detector stations will be compatible with existing and new traffic controller hardware, such as the CALTRANS 2070 controller standard. Nestor's Traffic Management System Strategy The Company's objectives are to be the high-quality supplier of intelligent video-based traffic monitoring systems to replace loop detectors at those sites where video has advantages in either functionality or cost and to capture new traffic monitoring applications beyond the capability of loop detector systems. The Company's strategy for achieving these objectives contains the following key elements: Expand national and worldwide distribution. The Company plans to target leading transportation departments (DOTs) initially through direct sales to provide convincing demonstrations of the products' superior performance, to create performance standards based upon enhanced functionality and to generate a market pull that will lead to volume distribution agreements with traffic integrators and traffic equipment suppliers. The Company intends to establish distribution agreements with domestic and foreign traffic integrators and installers. Maintain technology leadership and patent protection in developed solutions. As noted above, the Company has obtained patent protection for its proprietary neural networks and hardware systems (see "Patents") which the Company believes to be uniquely suited to applications that require field trainability or self- modification to adapt to new or changing patterns in the data. The Ni1000 chip allows for high-speed processing applications, such as video-image processing, on a personal computer platform. The Company continues to maintain and explore new patent protection rights for its proprietary software applications. The Company was issued a new patent in fiscal 1996, and has two applications pending relating to its work in the traffic- management areas. Ni1000 Chip, PCI 4000 Recognition Accelerator Board and IBM ZISC Chip Neural networks are inherently parallel systems whose operation, until recently, has only been simulated on serial computers. The relative slowness of serial simulation has prohibited the use of neural networks in many high-value applications that require high- speed learning and recognition. The Ni1000 Recognition Accelerator chip is an embodiment of the Company's technology that increases typical processing speeds by hundreds of times and is expected to open these previously untapped markets to neural- network solutions. Manufactured by Intel and introduced by the Company in June 1994, the Ni1000 chip was developed with funding by the Defense Advanced Projects Research Agency ("DARPA"). Commercial delivery of Ni1000 chips and Ni1000 Development Systems began in June 1994. In April 1994, the Company and Intel Corporation signed an agreement that provided the Company with exclusive marketing rights to the Ni1000 Recognition Accelerator, subject to certain minimum purchases of the Ni1000 Recognition Accelerator by the Company. (See "Licensing, Joint Venture and Development Agreements.") In connection with the development of the Ni1000 Recognition Accelerator, the Company and Intel were jointly named as winner of the 1994 Discover Awards for Technological Innovation in the category of Computer Hardware & Electronics. The Ni1000 Recognition Accelerator was selected by the editors of Electronic Design News as a finalist in their 1994 "Innovation of The Year" contest. Continued development work in neural-network hardware was centered on the development of a PC-compatible circuit-board incorporating multiple Ni1000 Recognition Accelerators, and associated development-environment software. Development of the circuit board and software were funded, in part, by a contract dated August 26, 1993, between the Company and Office of Naval Research and administered by the Defense Advanced Projects Research Agency of the Department of Defense ("DARPA"). PCI 4000 Recognition Accelerator Board An outgrowth of the Company's DARPA-funded development work is the PCI 4000 Recognition Accelerator, which was developed cooperatively with Alta Technology Corporation. The PCI 4000 is a circuit board containing up to four Ni1000 Recognition Accelerators and a Pentium controller, which is compatible with any PC or workstation that provides PCI (Peripheral Component Interconnect) support. IBM ZISCT Chip On January 31, 1996, the Company signed a technology licensing agreement with IBM to use Nestor's pattern recognition technology in an IBM developed neural-network semiconductor device called the ZISC (see "Licensing, Joint Venture and Development Agreements"). The Company believes that the entry of IBM into the field of neural-network applications may assist the Company in the marketing of its own hardware components. Internet Web Server Systems During 1996, the Company began development of an internet product incorporating the neural-network technology called Nestor InterSite. Nestor InterSite is server-side software that enables the Web host to understand individual on-line customers and dynamically present personalized content. To date, the Internet has largely been used as a medium for the broadcast of static information. Its potential for truly interactive dialogs has not been realized. However, the Internet, or more specifically the World Wide Web, is undergoing a revolution. New technologies are being introduced which will cause Internet web sites to become dynamic and personalized. Nestor InterSite will allow vendors to learn about their web visitor community, permitting the web host to tailor its products and services accordingly. Vendors should retain more customers, sell more products to those customers and identify customers who are interested in premium products and services. In 1997, two customers selected InterSite for beta installations. Lycos, Inc. is a free, global Internet navigation and community network which experiences millions of hits each day, and Edward Jones is the largest financial-services firm in the nation in terms of offices and is the only firm that serves individual investors exclusively. The firm traces its roots to 1871, and today serves more than 2.5 million customers. The Company has currently suspended further direct involvement in marketing and developing this product. Product development may resume if funded projects are requested by our current customers or distributors. Intelligent Character Recognition Products On June 11, 1996, the Company licensed the development and marketing rights in its Intelligent Character-Recognition ("ICR") products (NestorReader, OmniTools, and N'Route) to National Computer Systems, Inc. ("NCS"), and is no longer involved in developing, packaging and marketing these products (see "Licensing, Joint Venture and Development Agreements"). The Company receives royalties from the sales of these products and any enhanced versions of these products by the licensee. The following are the principal ICR products developed and marketed by the Company through June 11, 1996, and marketed by NCS since then: NestorReaderT NestorReader is a software product that is designed to perform character recognition from images of hand-printed and machine- printed characters in intelligent character recognition systems. A principal application of NestorReader has been to replace the human process of reading data from forms and entering the data into computers by means of a keyboard. NestorReader is licensed to original equipment manufacturers, value-added resellers and systems integrators for integration into image-processing systems. NestorReader extends the range of optical character recognition to include hand print and faxed characters at a price/performance ratio that the Company believes is unequaled by competitive technologies. In optical character recognition, existing techniques have successfully solved the problem of reading conventional, clean, machine-printed characters. Management believes that hand printed characters - with their high degree of variability - and faxed characters, with their high noise level, can only be read satisfactorily by more powerful technologies like NestorReader. OmniTools(R) OmniTools is a software product that enables corporate applications developers to access the functionality of NestorReader from within Windows applications without the need for C programming. Developers need only use such familiar tools as Visual Basic or applications macro languages including Visual Basic for Applications. ICR solutions can thus be developed from Access, Excel, Foxpro, Lotus 123, Paradox and other Windows applications. The Company began marketing OmniTools in fiscal 1994. N'Route(R) N'Route is a Windows end-user application that automatically routes incoming faxes and scanned images directly to their intended recipients. N'Route does this by recognizing the name or other identifier written on a document and then routing the document to its destination "mailbox" on Lotus Notes, cc:Mail or Windows for Workgroups users with Microsoft Mail. Installation and maintenance by a network administrator is by dialog boxes and menus and requires no programming or character-recognition expertise. In February 1995, N'Route was awarded the Imaging Magazine "Product of The Year" award for 1994. Sales, Marketing and Methods of Distribution The Company sells and markets its software and services in North America through a direct sales organization and through third- party licensing agreements. Outside of North America, the Company negotiates marketing agreements with various industry service providers. The Company's product lines are targeted toward large commercial users (e.g., banks for the PRISM, CampaignOne and InterSite products), or federal and state government agencies (e.g., Departments of Transportation for the TrafficVision product). The products require technical assistance through the sales and installation processes. Accordingly, the Company maintains an in- house staff of engineers to support the sales, installation, and customer-service functions. The Company's FDS and PRISM products are licensed directly by the Company to financial institutions. The TrafficVision products will be marketed directly to governmental traffic management departments or their chosen integrators. The Ni1000 Recognition Accelerator and the Ni1000 Development System are marketed directly by the Company to developers of high-speed applications, and are used in internally developed products. The Company's Intelligent Character Recognition products are marketed exclusively by NCS. The Company obtains product inquiries from product mailings, attendance at trade shows, media advertising, trade-press coverage and its internet site. In financial services, the Company has in the past created custom applications including risk assessment for bank-card fraud detection, mortgage origination and insurance, consumer credit and securities trading. Nestor's FDS and PRISM products are an outgrowth of such development projects. In the United States and Canada the Company markets FDS PRISM and CampaignOne directly. ACI is the Company's largest reseller, with offices and employees around the world. ACI has reseller rights to all of the Company's products on a stand-alone basis or packaged with their proprietary products. The Company has a worldwide license with Total System Services, Inc. (Total) to provide its PRISM product to customers for which Total provides card processing services (provided in North and Central America). In Japan, custom financial applications are marketed through its licensee, CSK Corporation. FDS and PRISM are licensed to applications developers in Europe and Japan under a standard, non- transferable, non-exclusive software license limited to a single computer. Developers of applications may not make, use or sell multiple copies of such applications without entering into additional licensing arrangements with the Company. Management of the Company believes that the success of the PRISM and FDS products will create a valuable franchise in each institution, leading to extensions of the Company's technology to other risk- assessment applications. During 1998, ACI, GE Consumer Credit Financial Services and Mellon Bank accounted for 28%, 20% and 14% of the Company's revenues, respectively. During 1997, ACI and Europay accounted for 39% and 16% of the Company's revenues, respectively. During the six months ended December 31, 1996, the Jet Propulsion Laboratory, GE Consumer Credit Financial Services, BankOne, Mellon Bank and Customer Services, Inc. accounted for 19%, 18%, 15%, 13% and 11%, of the Company's revenues respectively. In fiscal 1996, National Computer Systems and Europay International accounted for 30% and 13% of the Company's revenues, respectively. The loss of any of these customers for any reason could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is not required to maintain significant inventories in order to deliver its products. The Company does not generally grant payment terms to customers in excess of 90 days. As of December 31, 1998, the Company had a backlog of approximately $1,492,000 in undelivered development and installation contracts and $192,000 in prepaid royalties. At December 31, 1997, the Company had a backlog of approximately $248,000 in undelivered development and installation contracts and $259,000 in prepaid royalties. At December 31, 1996, the Company had a backlog of $209,000 in undelivered development and installation contracts and $582,000 in prepaid royalties. As of June 30, 1996, the Company had a backlog of $408,000 in undelivered development and installation contracts and $431,000 of prepaid royalties and fees. Technology The Company's technology deals with the problem of pattern recognition. When presented with a pattern of information, it can be valuable to identify that pattern, whether it is a pattern of fraudulent credit card use, fraudulent health care claims, handwritten characters, vehicles in a traffic flow, and so on. Several methods currently exist to address the problem of processing information in order to recognize a pattern in the information. Included among these are "expert" systems of rules, and neural networks. The Company's products combine both of these methods to optimize pattern recognition capabilities. Rule-Based Technology. The Company's systems employ expert or rule-based technology to define customer strategy, policy and procedures in its products. Rule-based systems contain decision trees of conclusions based on the existence of various conditions. For example, a credit card transaction has been authorized. To determine if that transaction was fraudulent and whether or not an account should be investigated, the following set of questions may be asked: has the card been reported lost or stolen since the transaction occurred? If "yes", the transaction equals "fraud"; if no, did the purchase amount exceed the credit limit? If "yes", did the purchase occur less than one hour after the previous purchase? If "yes, and so on. It is almost impossible to cover all possibilities of combinations of circumstances even with the most comprehensive suite of rules. So, while allowing the implementation of select rules may be beneficial, a decision based solely on rules may not always be correct or practical. Neural-Network Technology. Neural-networks simulate a virtual network of interconnected units, processing data in parallel, and communicating with each other at lightning speeds. A trained neural-network expects input and then outputs a response: either "unrecognized", "recognized", or "not sure". Exceeding the capability of if-then-else conditional rules, the power of the neural-networks is in their ability to accurately recognize input, such as attempting to recognize characters from a scanned handwritten sample, which is ill-defined (i.e. written in very light pencil), affected by "noise" (i.e. smudged), or blatantly unusual (i.e. overly large or small, or containing skewed characters). Nestor, as the result of extensive research, has created a proprietary neural-network technology referred to as the Restricted Coulomb Energy ModelT (RCE) which has been granted five patents. The RCE model has many unique features. It has the fastest learning and processing speed of any neural-network system. It has been demonstrated that the RCE will learn to recognize patterns orders of magnitude faster than a typical public domain neural-network such as Back Propagation (BP). RCE has the ability to add new features or classes without the need to retrain and re-engineer the complete system. For example, using BP, experts must re-engineer and completely retrain the entire system if new features or classes are added. Re-engineering and retraining is impractical for many real-world applications. RCE is a dynamic configuration of the network so that it can scale and configure itself to accommodate the complexity of a problem and make the most efficient use of available hardware. With BP, one must precisely engineer the number of neurons through experimentation in order to use the technology, and a stable solution is not guaranteed. Nestor has also been granted a sixth patent for a multi-unit system referred to as the Nestor Learning SystemT (NLS) which is ideally suited for many real-world pattern recognition applications. The NLS has a patented hierarchical, multi-network system for better control and accuracy. This approach is analogous to the way the human neural-network is believed to function. The Company believes that the rapid model development and operational flexibility afforded by its technology provides a competitive advantage in the development of intelligent-decision software solutions. Research and Development Activities of the Company The Company believes that its future depends upon its ability to improve its current technologies and products and to develop new technologies and products. The Company intends to pursue new and enhanced technologies and products. The Company attempts to locate external resources to assist in the costs of developing new technologies or products, but may bear all or a portion of such costs internally. The Company's research is almost entirely applied research intended to develop solutions to specific pattern-recognition problems. This research has resulted in various patents relating to improvements to the Company's basic technology (see "Patents"). The Company received one new patent in fiscal 1996 and one new patent in fiscal 1997 and has two applications pending as of December 31, 1998. These improvements are incorporated into the Company's products. The market for the Company's products may be impacted by changing technologies. The Company's success will depend upon its ability to maintain and enhance its current products and develop new products in a timely and cost-effective manner that meets changing market conditions. There can be no assurance that the Company will be able to develop and market on a timely basis, if at all, product enhancements or new products that respond to changing market conditions or that will be accepted by customers. Any failure by the Company to anticipate or to respond adequately to changing market conditions, or any significant delays in product development or introduction could have a material adverse effect on the Company's business, financial condition and results of operations. The Company expended in the years ended December 31, 1998 and 1997, in the six months ended December 31, 1996, and in the fiscal year ended June 30, 1996, respectively, $2,112,000, $1,498,000, $294,000 and $823,000 in support of the various aspects of Company-sponsored research and development. Patents The Company has continually sought and obtained patent protection for its proprietary neural networks and systems, which have as a principal feature rapid learning from a relatively small number of examples. The Company believes that this capability makes the Company's technology uniquely suited to applications that require field trainability or self-modification to adapt to new or changing patterns in the data. The Company's patents also cover multiple-neural-network systems, which enable the company to develop products that combine high accuracy with high processing speeds; and the Company's RCE neural network, which exhibits rapid learning and minimizes the internal connections needed for its functioning. This sparse connectivity has enabled the Company to develop, with Intel Corporation, a neural-network integrated circuit (the Ni1000 Recognition Accelerator chip) containing many more nodes than has been possible with other designs. The Company owns eight United States patents and eighteen foreign patents issued in eleven countries. In addition, there are two applications pending in the United States, and one application pending in Japan as of December 31, 1998. The foreign patents and patent application correspond to one or more of the United States patents. The Company believes that seven of its United States patents, and eleven corresponding foreign patents, are material to its business. These United States patents expire at various times from 1999 to 2014. The corresponding foreign patents expire at various times through 2007. The following table lists the Company's material United States patents: Year of Patent Date of Expira- Number Title Issue tion 4,326,259 Self-organizing General Pattern Class Separator and Identifier April 20, 1982 1999 4,760,604 Parallel, Multi-unit, Adaptive, Nonlinear Pattern Class Separator and Identifier July 26, 1988 2005 4,897,811 N-Dimensional Coulomb Neural Network Which Provides for Cumulative Learning of Internal Representations Jan. 30, 1990 2007 4,958,375 Parallel, Multi-unit, Adaptive Pattern Classification System Using Inter-unit Correlations And An Intra-class Separator Methodology Sept. 18, 1990 2007 5,054,093 Parallel, Multi-unit, Adaptive, Nonlinear Pattern Class Separator and Identifier Oct. 1, 1991 2008 5,479,574 Method and Apparatus for Adaptive Classification Dec. 26, 1995 2012 5,701,398 Adaptive Classifier Having Multiple Subnetworks Dec. 23, 1997 2014 Competition In the field of fraud-detection and risk-assessment systems, the Company encounters competition from a number of sources, including (a) other software companies, (b) companies' internal MIS departments, (c) network and service providers, and (d) neural-network tool suppliers. In the fraud-detection market, the Company has experienced competition from Fair, Isaac & Co., HNC Software, Inc., IBM, MasterCard Corporation, NeuralTech Inc., Neuralware, Inc., Visa International and others. The Company's fraud detection product also competes against other methods of preventing credit-card fraud, such as card-activation programs, credit cards that contain the cardholder's photograph, smart cards and other card authorization techniques. The introduction of these and other new technologies will result in increased competition for the Company and its products. In the field of traffic management systems, the Company's TrafficVision and CrossingGuard products (see "Recent Product Developments") face competition primarily from standard providers of existing loop system products. Other technologies exist from various sources that provide some of the basic traffic management functions provided by the loop system, such as Microwave, Ultrasonic, Infrared, and Acoustic. The Company believes that these technologies have limitations and do not provide the full range of options available through TrafficVision. Video-based systems are also available through other companies such as Econolite, Lockheed Martin, Peek Traffic, Odetics, Traficon, Siemens and Rockwell International. However, the Company believes that the platforms on which these video-based products operate do not provide the image processing capabilities possessed by TrafficVision, CrossingGuard and the Ni1000 Recognition Accelerator Chip. Red-light enforcement products are also available using loops and wet-film cameras through companies such as EDS, Lockheed Martin, Tellis and Red Flex. In the field of web server systems, the Company faces competition from a number of sources, including commodity-software providers, traditional database vendors, and vertical solution providers. The first two groups include such companies as Microsoft, Netscape and Oracle. Companies providing vertical solutions include BroadVision, Inc. and HNC Software, Inc. The market for internet-oriented products is intensely competitive with new competitors emerging frequently. Most of the Company's competitors have significantly greater financial, marketing and other resources than the Company. As a result, they may be able to respond more quickly to new or emerging technologies or to devote greater resources to the development, promotion and sale of their products than the Company. Competitive pressures faced by the Company may materially adversely affect its business, financial condition and results of operations. Employees As of December 31, 1998, the Company had 45 full-time employees, including 28 in product development, 8 in sales and marketing and 9 in finance and administration. One of the Company's current directors (and a founder of Nestor Associates) received the Nobel Prize in Physics in 1972. All of these employees are located in the United States. None of the Company's employees is represented by a labor union. The Company has experienced no work stoppages and believes its employee relationships are generally good. The Company's success depends to a significant degree upon the continued employment of the Company's key personnel. Accordingly, the loss of any of the Company's key personnel could have a materially adverse effect on the Company's business, financial condition and results of operations. No employee currently has an employment contract in place with the Company. The Company believes its future success will depend upon its ability to attract and retain industry-skilled managerial, engineering, software development and sales personnel, for whom the competition is intense. In the past, the Company has experienced difficulty in recruiting a sufficient number of qualified sales people. In addition, competitors may attempt to recruit the Company's key employees. There can be no assurance that the Company will be successful in attracting, assimilating and retaining such qualified personnel, and the failure to attract, assimilate and retain key personnel could have a materially adverse effect on the Company's business, financial condition and results of operations. Licensing, Joint Venture and Development Agreements The Company seeks to enter into license agreements and research and development contracts in order to obtain greater market penetration and additional funding of the development of its technology in specific fields of use. Total System Services, Inc. During the six month period ended December 31, 1996, the Company designed and installed a fraud detection system for Total System Services, Inc. (Total), a major provider of card processing services for financial institutions. Total provides PRISM fraud detection services to its customers along with the other transaction processing services. The Company receives fees based upon the number of transactions that are scored by PRISM. Applied Communications, Inc. (ACI) On April 18, 1997, the Company expanded its non-exclusive license agreement with ACI. The expanded license grants to ACI the right throughout the world to integrate and distribute all of the PRISM products. ACI provides authorization and transaction processing software to more than 500 customers throughout the world. The Company will receive royalties based on PRISM and other product license, engineering and ongoing use fees received by ACI from ACI sublicenses. In April 1998, ACI's parent company, Transaction Systems Architects, Inc. (TSAI) entered into a Stock Purchase Agreement with the Company. TSAI purchased 2.5 million shares of common stock for $5,000,000 and obtained a warrant purchase an additional 2,500,000 common shares for $7,500,000 shares which expires on March 1, 2002. National Computer Systems, Inc. (NCS) On June 11, 1996, the Company entered into an exclusive Licensing Agreement and an Asset Purchase Agreement with NCS transferring the development, production, and marketing rights of the Company's Intelligent Character Recognition (ICR) products to NCS. The Company received $1,400,000 as an initial license fee pursuant to the Licensing Agreement, and expects to receive royalties on future sales of the product by NCS. To maintain exclusive rights, minimum annual royalties range from $160,000 in 1997 to $350,000 in 2001 and beyond. In June 1998, NCS did not meet its minimum royalty for the license year and forfeited exclusive rights. The Asset Purchase Agreement transferred tangible and intangible assets used exclusively in the ICR business to NCS for $300,000. The initial license fee and asset sale proceeds were recognized as revenues in Fiscal 1996. IBM ZISC(tm) On January 31, 1996, the Company signed a technology licensing agreement with IBM to use Nestor's pattern recognition technology in an IBM developed neural network semiconductor device. IBM has the right to use the technology in the IBM ZISC (zero instruction set computing) digital integrated Neural Network chip and in future versions of the chip and related product enhancements. The IBM ZISC chip is expected to enable such complex mission- critical applications as image recognition for satellite, military and medical operations, financial data management and risk assessment, automotive applications, as well as highly sensitive identification systems such as sonar and fingerprinting and other crime-scene type analysis. The Company receives royalties from the sales by IBM of the chip and related products. California Institute of Technology Jet Propulsion Laboratory (JPL) On September 1, 1995, the Company commenced a partially funded development agreement with JPL to design a Traffic Surveillance and Detection Technology capable of directly measuring desired traffic parameters simultaneously, combined with higher accuracy and at a lower cost than available with current technology. The Company is applying its expertise in rapid pattern recognition and neural network designs to the project. The prototype and initial program was completed in December 1996. The Company began a Phase II contract for field testing of the prototype in 1997 and expects to complete this work in the first quarter of 1999. The total value of the expanded contract is $730,000, of which $726,000 had been recognized as revenue by December 31, 1998. DARPA The Company entered into a development agreement dated March 13, 1990 with DARPA for the development of a neural-network chip prototype embodying the Company's proprietary technology. On April 21, 1992 the Company and DARPA agreed to increase the contract to approximately $1,630,000 and extended the expected completion date to May 1993. In May 1990, the Company signed a Technology Development Agreement with Intel Corporation, under which Intel agreed to provide the design and manufacturing capabilities to satisfy the requirements of the contract with DARPA. The total cost to the Company of the subcontract with Intel is $750,000. On April 30, 1992, the cost of the subcontract was increased to $1,050,000. During the year ended June 30, 1993 the Company included in revenue approximately $436,000 relating to its work under the DARPA contract. On August 26, 1993, the Company entered into a follow-on program with DARPA to design and produce a PC compatible application design and development environment, comprising both hardware and software, which will enable users to incorporate the Ni1000 into products. The total value of this contract, which was completed in December 1995, was $776,167, of which approximately $423,000 was realized in fiscal 1994. CSK On June 13, 1996, the Company executed a nonexclusive PRISM Reseller Agreement with CSK Corporation to market, install, maintain, train and support the PRISM product in Japan. The agreement was for an initial term of two years and is being renewed annually. As of December 31, 1997, CSK had installed PRISM at Nippon Shinpan Company (NICOS), a leading credit card issuer in Japan. Intel Corporation On October 15, 1993, the Company and Intel Corporation entered into a license agreement, pursuant to which Intel acquired a non- exclusive right to develop and sell products incorporating the Company's technology. On April 7, 1994, the license agreement was amended to grant to the Company exclusive marketing rights to the Ni1000 Recognition Accelerator Chip, which Intel will manufacture and sell to the Company. In accordance with the license agreement, Intel notified the Company of its intention to phase out manufacturing of chips based on the .8 micron geometry. The Company placed a purchase order in 1997 and took delivery of an order for 1,000 units in early 1999. Given the number of chips the Company has in inventory and potential alternate development options, management does not believe there will be a material adverse impact on its operations as a result of the termination of the manufacturing of the current version of the Ni1000 chips. ITEM 2. Properties. The Company leases offices and research and development facilities, consisting of approximately 13,000 square feet, located at One Richmond Square, Providence, Rhode Island 02906, for which the annual base rental is $195,000. The Company believes these facilities will be adequate to serve its needs in the foreseeable future. ITEM 3. Legal Proceedings. On October 6, 1998, HNC Software Corp. ("HNC"), a significant competitor of the Company's in the field of Financial Services, obtained a patent entitled "Fraud Detection Using Predictive Modeling" and began advising prospective customers of the Company of the patent. Upon review of the patent and consideration of prior actions taken by HNC, the Company initiated a lawsuit against HNC in Providence, RI on November 25, 1998 alleging a number of claims including; 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 patent. The suit seeks various damages, including lost profits and treble damages. Costs associated with the suit are being expensed as incurred. No estimate of the outcome of this suit, or a potential countersuit, if any, can currently be made. ITEM 4. Submission of Matters to a Vote of Security Holders. No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1998. ITEM 5. Market for Registrant's Common Stock and Related Securityholder Matters The Company's common stock was first offered to the public in December, 1983. The principal market in which the Company's common stock is traded is the over-the-counter market. The quotations below reflect inter-dealers prices, and do not include retail markups, markdown or commissions and may not necessarily represent actual transactions. The shares of common stock are traded in the over-the-counter market and bear the symbol "NEST". Low Bid High Ask Year Ended 12/31/98 1st Quarter 1-3/4 2-35/64 2nd Quarter 1-57/64 3-1/8 3rd Quarter 7/8 2-33/64 4th Quarter 5/16 1-7/16 Year Ended 12/31/97 1st Quarter 1-21/32 2-9/16 2nd Quarter 1-3/4 2-9/16 3rd Quarter 1-1/4 2-9/32 4th Quarter 1-1/4 3-1/16 Period Ended 12/31/96 1st Quarter 1-11/16 3-1/4 2nd Quarter 2-1/8 3 Year Ended 6/30/96 1st Quarter 1-1/4 1-11/16 2nd Quarter 9/16 1-3/8 3rd Quarter 23/32 2-3/16 4th Quarter 1-3/8 3-3/16 As at March 12, 1999, the number of holders of record of the issued and outstanding common stock of the Company was 424, which includes brokers who hold shares for approximately 1,546 beneficial holders. The Company has not declared any cash dividends with respect to its common stock since its formation. ITEM 6. Selected Financial Data
Six Months Years Ended Ended December 31, December 31, Years Ended June 30, 1998 1997 1996 1996 1995 1994 Operating revenue $ 2,241,376 $ 5,681,076 $1,195,904 $5,461,580 $ 3,195,563 $ 2,230,474 Other income (expense) $ (26,178) $ 31,321 $ (16,220) $ 39,950 $ (221,024) $ (282,418) Net income (loss) $(5,263,153) $ (294,664) $(935,337) $ 12,690 $(3,457,422) $ (1,758,584) Earnings per share Weighted number of outstanding shares-- basic and diluted 15,249,932 9,243,508 8,689,031 7,847,510 7,411,502 6,840,407 (Loss) per share $ (0.36) $ (0.08) $ (.13) $ (0.03) $ (.48) $ (.26) SELECTED BALANCE SHEET DATA: Total assets $ 2,591,589 $ 2,613,031 $2,817,944 $3,351,871 $ 1,812,495 $ 1,096,314 Working capital $ 551,461 $ 146,081 $ 879,172 $1,983,661 $(1,882,875) $ 220,243 Long-term Redeemable Preferred Stock $ --- $ 5,792,787 $5,398,908 $5,207,538 $ 1,600,328 $ --- Capital leases $ 22,618 $ 10,220 $ 9,455 $ 9,455 $ --- $ 3,363 Deferred income $ --- $ --- $ 430,899 $ 430,899 $ 438,896 $ 954,491
ITEM 7: Management's Discussion and Analysis Prospective Statements The following discussion contains prospective statements regarding Nestor, Inc., its business outlook and results of operations, all of which are subject to certain risks and uncertainties and to events that could cause the Company's actual business, prospects and results of operations to differ materially from those that may be anticipated by, or inferred from, such prospective statements. Factors that may affect the Company's prospects include, without limitation: the Company's ability to successfully develop new contracts for technology development; the impact of competition on the Company's revenues or market share; delays in the Company's introduction of new products; and failure by the Company to keep pace with emerging technologies. Readers are cautioned not to place undue reliance on these prospective statements, which speak only as of the date of this report. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's reports filed with the Securities and Exchange Commission. Liquidity and Capital Resources Cash Position and Working Capital The Company had cash and short-term investments of approximately $1,175,000 at December 31, 1998, as compared with $387,000 at December 31, 1997. At December 31, 1998, the Company had working capital of $551,000, as compared with $146,000 at December 31, 1997. The increase in working capital from 1997 to 1998 reflects primarily the proceeds from the sale of $5,000,000 in common stock during the year offset by cash used by current-period operating activities of $3,899,000 and equipment purchases of $132,000. The Company had a net worth of $984,000 at December 31, 1998, as compared with a negative net worth of $4,519,000 at December 31, 1997. The increase in net worth resulted from the issuance of $5,000,000 of common stock and the conversion of $5,793,000 in redeemable preferred stock to common stock, offset by the current period operating loss of $5,263,000. As a result of its financial performance during 1998, the Company ceased further investments in development and marketing of its Internet product "InterSite". The net investment incurred by the Company in this product in 1998 was $1,383,000. Additional capital will be required to enable the Company to carry out needed marketing campaigns for its products, for continued development and upgrading of its products and for customer support. On 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. Principal payments are due in twelve equal installments beginning March 1, 2001. Interest on the loan is equal to the effective prime interest rate plus 1% and payments are due quarterly in arrears beginning July 10, 1999. The line may be reduced to $500,000 if the Company's equity becomes negative or increased up to $4,000,000 if certain financial requirements are attained. On March 25, 1999, Nestor Traffic Systems, Inc., a subsidiary of the Company, sold a 37.5% common-stock interest in it to a private group of investors for $2,350,000 in cash and issued an option for an additional 17.5% of its common stock for $1,750,000. The investor group includes three officers of the Company and the subsidiary, who in the aggregate contributed $600,000 of the initial cash invested on the same basis as third- party investors. The option expires on January 31, 2000. The proceeds will be used by the subsidiary to fund traffic-system product development and marketing efforts in 1999. In addition, to the extent that facility and administrative services of the Company are used by the subsidiary, reimbursement of allocated costs will be provided. The subsidiary has an exclusive license from the Company to apply the Company's proprietary technologies in the area of traffic-management systems. The license provides for royalties to the Company of 5% of related revenues, net of direct cost of third party goods sold, in 2000 and 10% in 2001 and beyond. The capital invested in the subsidiary will be used to fund the expenses of Traffic Systems incurred after January 1, 1999, which were funded by the Company in previous years. Management believes that the Company's revenues will generate sufficient liquidity, when combined with its liquid assets as of December 31, 1998 and the financings described above, to meet the Company's anticipated cash requirements from current operations through the end of the year ending December 31, 1999. If the Company does not realize revenues sufficient to maintain its operations at the current level, management of the Company would curtail certain of the Company's operations until additional funds become available through investment or revenues. Litigation On October 6, 1998, HNC Software Corp. ("HNC"), a significant competitor of the Company 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 patent. The suit seeks various damages, including lost profits and treble damages. Costs associated with the suit are being expensed as incurred. No estimate of the outcome of this suit, or a potential countersuit, if any, can currently be made. Deferred Income Operations of the Company have been partly funded by prepayments under engineering contracts and licenses of the Company's technology. Such prepayments are recognized as revenue upon delivery of the product and completion of related engineering or other services necessary under the contract, or under the percentage-of-completion method as engineering is completed or delivery obligations are fulfilled. The Company bases its estimate of the percentage of completion on the amount of labor applied to a given project compared with the estimated total amount of labor required. The remainder of such prepaid revenue is reflected on the Company's balance sheet as deferred income. Total deferred income was $434,000 at December 31, 1998, as compared with $408,000 at December 31, 1997. In June 1997, the Company and Sligos, S.A. terminated their license agreement dated October 26, 1990. The Company paid to Sligos $225,000 in July 1997 in full settlement of its current liability due to Sligos and of the repurchase of 452,064 shares of the Company's Series A Preferred Stock. The Company also eliminated $431,000 of long-term deferred income related to Sligos prepayments received in 1990, which had not been taken into income. (See "Results of Operations" below.) Future Commitments During the year ended December 31, 1998, the Company acquired additional property and equipment (primarily computers and related equipment) at a cost of $132,000. The Company valued its investments in computers and related equipment (net of depreciation) at $369,000 at December 31, 1998. The Company has no material commitments for capital expenditures although management expects that the Company may make future commitments for the purchase of additional computers and related computing equipment, for furniture and fixtures, for development of hardware, for consulting and for promotional and marketing expenses. The Company maintains a lease for office space totaling approximately 13,000 square feet. The lease provides for monthly rent, including utilities except electricity, in the amount of $16,250 and expires in February 2000. The Company believes the facilities are adequate for its 1999 needs. The Company had placed purchase orders totaling $877,500 with Intel Corporation for a supply of the Ni1000 Recognition Accelerator Chips. The Company received delivery of $195,000 of the chips during February 1999. The Company canceled its outstanding purchase order for the remaining chips in February 1999. The Company's subsidiary, Nestor Traffic Systems, Inc., entered into an agreement on September 25, 1997, for the modification of one of the components of the TrafficVision product. Nestor agreed to pay Zeller Research, Ltd. $75,000 for engineering, which is expected to be completed during the first quarter of 1999, and to purchase 100 units of the modified component at a total cost of up to $53,000. Additional orders may be placed with this vendor to supply components of traffic-system products based upon third party orders received. Year 2000 Year 2000 problems may arise in computer equipment and software, as well as embedded electronic systems, because of the way these systems are programmed to interpret certain dates that will occur around and after the change in century. In the computer industry, this is primarily the result of computer programs being designed and developed using or reserving only two digits in year fields (rather than four digits) to identify the century, without considering the ability of the program to properly distinguish the upcoming century change in the Year 2000. In addition, the Year 2000 is a special-case leap year, and some programs may drop February 29, 2000 from their internal calendars. Other dates may present problems because of the way the digits are interpreted. Because the Company's business is based on the licensing of application software, the Company's business would be adversely impacted if its products or its internal systems experience problems associated with the century change. This issue also potentially affects the software programs and systems used by the Company in its operations. In 1998, the Company initiated a company-wide program to analyze three specific categories of systems; (1) software developed by the Company which is licensed to customers, (2) software utilized by the Company consisting of applications developed in-house and purchased from third party suppliers, and (3) systems and embedded technology which are integral components of the infrastructure of the Company. The Company developed and acquired tools, which were utilized during the testing of software and systems. The Company believes that its remediation efforts with respect to its licensed software will be successful. The Company's belief is based upon its own testing by simulating dates and upon testing by many of the customers of the Company who have in turn completed their own Year 2000 testing. The Company continues to actively monitor the status and progress of customers and distributors and to assess the risk associated in those cases where the customer has not taken delivery of the compliant version or may not have made satisfactory progress in their own Year 2000 testing. Following analysis, remediation and testing efforts, the Company began shipping Year 2000 compliant versions of all licensed software applications in November 1998. As of December 31, 1998, all of the Company's currently licensed software applications are Year 2000 compliant and available to customers. With respect to its own systems, testing, remediation, and/or replacement is underway and has been substantially completed in the most critical areas. The Company anticipates it will complete its Year 2000 compliance efforts by the third quarter of 1999. The Company expects to incur project costs of approximately $250,000 over the life of the Year 2000 project. These costs consist of: (i) internal staff costs related to licensed product remediation and testing; (ii) internal staff costs related to internal software and system compliance; (iii) hardware and software costs for replacement of software; and (iv) costs related to compliance involving embedded systems. Costs incurred from the beginning of the project in 1997 through December 1998 have totaled approximately $150,000. The Company expects to incur an additional $100,000 over the remaining life of the project. All costs of the Year 2000 project are being expensed as incurred. The estimated remaining costs are based upon currently known circumstances and various assumptions regarding future events. There can be no assurance that this estimate will be achieved and actual results could differ materially from those anticipated. Except for statements of existing or historical facts, the foregoing discussion consists of forward-looking statements and assumptions relating to forward-looking statements, including without limitation the statements relating to the timetable for completion of the Year 2000 compliance efforts, future costs, potential problems relating to Year 2000, the Company's state of readiness, third-party representations, and the Company's plans and objective for addressing the Year 2000 problems. Certain factors could cause actual results to differ materially from the Company's expectations, including without limitation (i) the failure of existing or future customers to achieve Year 2000 compliance; (ii) the failure of computer hardware system providers on which the Company and its customers rely, or other vendors or service providers of the Company or its customers, to timely achieve Year 2000 compliance; (iii) the Company's product and systems not containing all necessary data code changes; (iv) the failure of the Company's analysis and testing to detect operational problems in software utilized by the Company or in the Company's products or services, whether such failure results from the technical inadequacy of the Company's validation and testing efforts, the technical unfeasibility of testing certain software, and the unavailability of customers or other third parties to participate in testing; (v) potential litigation arising out of Year 2000 issues with respect to providers of software and related technical and consulting services such as the Company generally provides, and particularly in light of the numerous interfaces between Company products and the products and services of third parties, which are required to successfully utilize the Company's products, which could involve the Company in expensive, multiple-party litigation even though the Company may have no responsibility for the alleged problem; and (vi) the failure to timely implement a contingency plan to the extent that Year 2000 compliance is not achieved. Inflation Management believes that the rate of inflation in recent years has not had a material effect on the Company's operations. Results of Operations Analysis of the Years Ended December 31, 1998 and 1997 In the year ended December 31, 1998, the Company realized a 61% decrease in revenues compared to the prior calendar year. Expenses increased 25% in 1998 resulting in a 1,690% increase in the operating loss when compared with the prior year. During 1998, the Company determined that it would not have adequate financial resources to continue the development and marketing efforts required to commercialize the Internet marketing product InterSite. After unsuccessful attempts to obtain independent financing for the product line, during the fourth quarter of 1998, the Company decided to eliminate all current costs associated with the product and transferred it to the Financial Services division. Intangible assets associated with this product line totaling $295,000 were written-off in 1998. The Company executed a license agreement on March 28, 1997 for a customized copy of its PRISM Fraud Detection System, and had capitalized $575,000 of costs associated with the installation of the system as of December 31, 1997. Since the installation, the Company has continued to modify and improve the software. The system was deployed in December of 1998 to a limited number of initial customers, and began generating monthly revenue. In consideration of the delays in implementation, estimated ongoing support costs in relation to current revenue levels, and the remaining term of the license, the Company recorded an adjustment to the carrying value of the system of approximately $400,000 in the fourth quarter of 1998, reducing capitalized deferred costs to $80,000. These costs are being amortized over the remaining life of the associated license. Revenues The Company's revenues arise from licensing of the Company's products and technology, from the sale of tangible products, and from contract engineering services and are discussed separately below. During the year ended December 31, 1998, revenues decreased $3,440,000 to $2,241,000 from $5,681,000 in the prior calendar year. Non-recurring revenues in the year-earlier period included $2,000,000 of revenues associated with a license agreement with Applied Communications, Inc. ("ACI") in April 1997, and $480,000 recognized upon the termination of a license agreement with Sligos in June 1997. Software Licensing Product-licensing revenues totaled $4,390,000 in 1997, as compared with $1,352,000 in 1998. The decrease in these revenues reflects a decrease in license fees realized from PRISM products. PRISM licensing revenues amounted to $1,318,000 in 1998, a decrease of $2,945,000 from year-earlier revenues of $4,263,000. The decrease in PRISM-related licensing revenues reflects non- recurring revenues in 1997 of $2,000,000 from ACI and $480,000 from Sligos. The remainder of the decrease reflects a decrease in new initial licenses realized in 1998. During the year ended December 31, 1997, the Company realized $120,000 of royalty revenue from National Computer Systems, Inc. ("NCS"), as compared with $32,000 in 1998. In June 1998, NCS elected not to meet its minimum royalty requirement to maintain an exclusive right to the marketing of the Company's image character recognition products. The license with NCS continues on a non-exclusive basis. Engineering Services Engineering revenues totaled $746,000 in 1998, as compared with $1,055,000 in 1997. Revenues relating to new license installations and customer-funded modifications of Nestor's PRISM product totaled $613,000 in 1998, a decrease of $356,000 from $969,000 of such revenues in 1997. The decrease is related to the drop in new PRISM licenses, and the associated installation work, noted in "Software Licensing" above. On September 1, 1995, the Company signed a contract with the Jet Propulsion Laboratory (JPL) to develop a prototype sensor system designed for vehicular-traffic surveillance and detection. The contract was valued at approximately $597,000. On March 31, 1997, the Company extended its contract with JPL to include in- field evaluation of the prototype system developed under the original JPL contract, and the value of the contract was increased to $730,000, of which approximately $726,000 had been earned as of December 31, 1998,. The terms of the JPL contract call for delivery of prototype products, but do not specify any subsequent purchasing or licensing provisions. During the year ended December 31, 1998, the Company recognized revenues totaling $89,000 under its government contracts. In the year-earlier period such revenues totaled $86,000. During 1998, the Company realized $44,000 of revenues related to engineering work on its InterSite product. No such revenues were realized in 1997. Sales of Tangible Products The tangible products currently sold by the Company are based upon the Company's Ni1000 Recognition Accelerator Chip which is incorporated into the Traffic Systems product line or is licensed with development software that enables customers to develop their own high-speed recognition applications. Revenues from the Company's Ni1000 Development System totaled $70,000 in the year ended December 1998, as compared with $111,000 in the prior year. The Company is continuing its development of the TrafficVision and CrossingGuard products, which incorporate the Ni1000 Recognition Accelerator Chip (see "Investment in Product Development and Marketing," below). Revenues from the Company's Traffic Systems products totaled $73,000 in the year ended December 1998, as compared with $130,000 in the prior year. Operating Expenses Total operating expenses - consisting of engineering, research and development, selling and marketing, and general and administrative expenses - amounted to $7,478,000 in the year ended December 31, 1998, an increase of $1,501,000 over total operating costs of $5,977,000 in the prior year. Included in operating expenses in 1998 are write-downs of Deferred Development Costs and other intangibles of approximately $400,000 in the financial services division and $295,000 in the InterSite product line. Engineering Services Costs related to engineering services totaled $2,067,000 in 1998, as compared with $1,151,000 in 1997. The increase in these costs reflects the write-offs totaling approximately $695,000 discussed above. The remaining increase is due primarily to general cost increases incurred in 1998. Research and Development Research and development expenses totaled $2,112,000 in the year ended December 31, 1998 as compared with $1,498,000 in the prior year. The increase in such costs reflects the net of increased investment in product development in all of the Company's product lines in the current year, including PRISM V3.0 shipped in the fourth quarter of 1998, development of CrossingGuard which is being delivered to Vienna, VA in the first quarter of 1999, and development of InterSite through November of 1998. Development costs should decrease substantially in 1999 as a result of the termination of further InterSite development in November 1998; additionally, in view of its independent financing, the Company will share the development costs associated with Nestor Traffic Systems, Inc. Selling and Marketing Selling and marketing costs decreased $155,000 to $1,832,000 in the year ended December 31, 1997, from $1,986,000 in the prior year. The decrease in selling costs in the year reflects, primarily, reduced commissions incurred in conjunction with reduced revenues. Selling costs relating to the Company's PRISM product line totaled $1,103,000 in 1998, as compared to $1,360,000 in 1997. The decrease is due to a $174,000 decrease in commission expense and reduced Advertising and Meeting expenses resulting from charging an attendance fee to the 1998 Risk Symposium meeting. Selling costs relating to the Company's Traffic Systems product and Ni1000 Development System totaled $536,000 in 1998, as compared with $552,000 in 1997. Selling costs associated with InterSite, in which the Company ceased further investment effective November 1998, totaled $192,000 in 1998, which was unchanged from the prior year. General and Administrative General and administrative expenses totaled $1,413,000 in 1998, as compared with $1,207,000 in the previous year. General and administrative costs for the year ended December 1998 reflect increased legal expenses related to the lawsuit initiated against a competitor in November 1998 and increased accounting fees. Other Income (Expense) For 1998, net other expense was $26,000, as compared with net other income of $31,000 in the year-earlier period. In June 1997, the Company recorded other income of $100,000 as a discount on the payment relating to the termination of the License Agreement with Sligos. In 1998, other expense was comprised primarily of $106,000 of amortization expense related to the assigned value of warrants outstanding offset by $73,000 of interest income. Investment in Product Development and Marketing With the exception of $80,000 related to a custom PRISM installation at December 31, 1998, the Company has not capitalized any expenses relating to the development or marketing of its products. The following information details the amounts by which the Company's expenses in connection with each of its major product lines exceeded revenues for such product lines. The largest net investment made by the Company was in its Traffic Systems subsidiary, which is responsible for the development and marketing of the TrafficVision and CrossingGuard products. The Company delivered a few TrafficVision products during 1998, but concentrated most of its efforts on the development of the CrossingGuard product of which a first beta version was delivered in the first quarter of 1999. For the year ended December 31, 1998, expenses of this subsidiary exceeded revenues by $1,933,000. The Company began development in July 1996 of products for use in Internet and intranet environments. Costs associated with this effort totaled $628,000 in 1997. The Company continued its investment in this subsidiary in 1998 and initiated efforts to locate independent third party financing. These efforts were not successful, and the Company ceased further investment in development of this product line in November 1998. The net investment in this subsidiary during 1998 was $1,383,000. The Company made a net investment in its PRISM product line during 1998 of $1,954,000. Net Income During 1998, the Company experienced a loss of $5,263,000, as compared with a loss of $295,000 in the prior year. For the year ended December 31, 1998, loss per share available for common stock was $0.36 per share, as compared with a loss per share of $0.08 in the corresponding period of the prior fiscal year. For the year ended December 31, 1998, there was outstanding a weighted average of 15,249,932 shares, as compared with 9,243,508 in the year-earlier period. Analysis of the Years Ended December 31, 1997 and 1996 In the year ended December 31, 1997, the Company realized a 26% increase in revenues compared to the prior calendar year. Expenses increased 22% in 1997 resulting in a 27% decrease in the operating loss when compared with the prior year. On June 11, 1996, the Company entered into an exclusive Licensing Agreement with NCS transferring the development, production, and marketing rights of the Company's Intelligent Character Recognition (ICR) products to NCS. Pursuant to the License Agreement, NCS paid the Company an initial license fee of $1,400,000, and has paid a ten percent royalty on revenues NCS has realized from the ICR products since their transfer to NCS. Such revenues, including the initial license fee, accounted for 47% of revenues in calendar 1996, including the initial license fee, as compared to 2% in 1997. In the quarter ended September 30, 1996, the Company began a project to customize its PRISM Fraud Detection System for a customer. Because the terms of the agreement had not been finalized, the Company accounted for the development costs in accordance with SOP 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts," which provides that costs be deferred until delivery is made under the terms of an enforceable agreement. For the year ended December 31, 1996, the Company deferred $364,000 of costs associated with this project. The Company executed a license agreement on March 28, 1997, made required deliveries, and recognized in the quarter ended March 31, 1997, $550,000 of revenues under this contract. Since the installation, the Company has continued to modify and improve the software although the customer has not yet deployed it. While management expects that the customer will deploy the software, management is not able to forecast when it will be deployed. Accordingly, the revenues associated with this contract were reversed in the fourth quarter of 1997 and $575,000 of costs were capitalized as Deferred Development Costs at December 31, 1997. The deferred development costs will be amortized over the remaining life of the license upon deployment by the customer. (See 1998 developments previously discussed.) Revenues The following table compares revenues for calendar 1997 with calendar 1996 including and excluding revenues from ICR operations transferred to NCS: Total Total Total Revenues Revenues Revenues Yr. Ended Yr. Ended Yr. Ended 12/31/96 12/31/97 12/31/96 Change Excluding ICR Change $5,681,000 $4,508,000 +26% $2,379,000 +138% The Company's revenues arise from licensing of the Company's products and technology, from the sale of tangible products, and from contract engineering services and are discussed separately below. During the year ended December 31, 1997, revenues increased $1,173,000 to $5,681,000 from $4,508,000 in the prior calendar year. Revenues in the year-earlier period included $2,129,000 of revenues associated with the ICR products that were licensed exclusively to NCS in June 1996. Software Licensing Product-licensing revenues totaled $4,396,000 in 1997, as compared with $2,450,000 in 1996. The increase in these revenues reflects the net of an increase in license fees realized from the PRISM products and the decrease in licensing revenues from the ICR products transferred to NCS. PRISM licensing revenues amounted to $4,263,000 in 1997, an increase of $3,366,000 from year-earlier revenues of $416,000. The increase in PRISM-related licensing revenues results from an increase in unit volume through the Company's resellers, Applied Communications, Inc. ("ACI"), Europay International, S.A., and CSK Corporation ("CSK"). During the year ended December 31, 1997, the Company realized $120,000 of royalty revenue from NCS, as compared with $1,958,000 of ICR licensing revenues, the initial license fee from NCS, and subsequent royalties from NCS realized in 1996. Engineering Services Engineering revenues totaled $1,055,000 in 1997, as compared with $1,908,000 in calendar 1996. Revenues relating to customer- funded modifications of Nestor's PRISM product totaled $969,000 in 1997, a decrease of $260,000 from $1,229,000 of such revenues in 1996. The Company's contract with the Defense Advanced Research Projects Agency (DARPA) requires engineering services rendered by the Company to develop a circuit board for use with the Ni1000 Recognition Accelerator Chip. The contract, signed August 26, 1993, is in the amount of $776,000; as of December 31, 1997, approximately $773,000 had been earned. On September 1, 1995, the Company signed a contract with the Jet Propulsion Laboratory (JPL) to develop a prototype sensor system designed for vehicular-traffic surveillance and detection. The contract was valued at approximately $597,000. On March 31, 1997, the Company extended its contract with JPL to include in- field evaluation of the prototype system developed under the original JPL contract. The value of the contract was increased to $730,000; as of December 31, 1997, approximately $657,000 had been earned. The terms of the DARPA and JPL contracts call for delivery of prototype products, but do not specify any subsequent purchasing or licensing provisions. During the year ended December 31, 1997, the Company recognized revenues totaling $67,000 under its government contracts. In the year-earlier period such revenues totaled $507,000. Sales of Tangible Products The tangible products currently sold by the Company are based upon the Company's Ni1000 Recognition Accelerator Chip, which is marketed along with development software that enables customers to develop high-speed recognition applications. Revenues from the Company's Ni1000 Development System totaled $105,000 in the year ended December 1997, as compared with $149,000 in the prior year. The Company is continuing its development of the TrafficVision product, which will incorporate the Ni1000 Recognition Accelerator Chip (see "Investment in Product Development and Marketing," below). During the year ended December 1997, initial commercial shipments of TrafficVision totaled $130,000. Operating Expenses Total operating expenses - consisting of engineering, research and development, selling and marketing, and general and administrative expenses - amounted to $5,977,000 in the year ended December 31, 1997, an increase of $1,065,000 over total operating costs of $4,912,000 in the prior year. Included in the year ended December 31, 1997 and 1996, were $0 and $972,000, respectively, of expenses attributable to the ICR products, which were licensed to NCS in June 1996. Expenses associated with the ICR products are no longer incurred by the Company as NCS hired most of the Company's staff assigned to development, sales, and support of the ICR products. Engineering Services Costs related to engineering services totaled $1,151,000 in 1997, as compared with $1,927,000 in 1996. The decrease in these costs reflects the decrease in engineering-services revenues. As a percentage of such revenues, engineering costs totaled 109% of related revenues in 1997, as compared with 101% of similar revenues in the year-earlier period. Research and Development Research and development expenses totaled $1,498,000 in the year ended December 31, 1997, as compared with $628,000 in the prior year. The increase in such costs reflects the net of increased investment in product development in all of the Company's product lines in the current year and the absence of product development relating to the ICR products. Investment in the ICR products in the year ended December 31, 1996 totaled $295,000. Selling and Marketing Selling and marketing costs increased $662,000 to $1,986,000 in the year ended December 31, 1997, from $1,324,000 in the prior year. The increase in selling costs in the year reflects, primarily, the net of two effects: an increase in sales and marketing costs in each of the Company's product lines and the absence of selling costs relating to the ICR products. PRISM selling costs totaled $1,279,000 in the year ended December 1997, as compared with $406,000 prior year. Selling costs relating to the Company's TrafficVision product and Ni1000 Development System totaled $514,000 in 1997, as compared with $279,000 in 1996. Selling costs associated with InterSite, which the Company began to develop in July 1996, totaled $195,000 in 1997, as compared with $31,000 in the prior year. Selling and marketing costs relating to the ICR products totaled $0 and $605,000 in 1997 and 1996, respectively. General and Administrative General and administrative expenses totaled $1,207,000 in 1997, as compared with $975,000 in the previous year. General and administrative costs for the year ended December 1996 reflect the capitalization of $76,000 of costs associated with the PRISM development project. Apart from that item, the increase in general and administrative costs reflects the growth of the Company's three businesses. Other Income (Expense) For 1997, net other income was $31,000, as compared with net other income of $204,000 in the year-earlier period. In June 1997, the Company recorded other income of $100,000 as a discount on the payment relating to the termination of the License Agreement with Sligos. In June 1996, the Company recorded other income of $213,000 as a gain on the sale of intangibles relating to the sale of the ICR products to NCS. Investment in Product Development and Marketing In 1996 and 1997, the Company had not capitalized any expense relating to development or marketing of its products. The following information details the amounts by which the Company's expenses in connection with each of its major product lines in those years exceeded early-stage revenues for such product lines. The largest investment made by the Company was in its Intelligent Sensors subsidiary, which is responsible for the development and marketing of the TrafficVision products, an outgrowth of work under the JPL contract. The Company extended its contract with JPL and made initial commercial deliveries in the September 1997 quarter. For the year ended December 31, 1997, expenses of this group exceeded revenues by $1,127,000. The Company began development in July 1996 of products for use in internet and intranet environments. Costs associated with this effort totaled $628,000 in 1997. In October 1997 Lycos, Inc., which hosts one of the most active Web sites on-line, selected Nestor's InterSite product to provide intelligent personalization for Lycos' global Internet navigation center. The Company did not make any net investment in its PRISM product line or in its Fraud Detection System. Revenues relating to the Company's PRISM Fraud Detection System exceeded expenses by $2,544,000 in 1997, including $480,000 of license revenue relating to the termination of the License Agreement with Sligos. Net Income During 1997, the Company experienced a loss of $295,000, as compared with a loss of $199,000 in the prior year. For the year ended December 31, 1997, loss per share available for common stock was $0.08 per share, as compared with a loss per share of $0.09 in the corresponding period of the prior fiscal year. For the year ended December 31, 1997, there were outstanding a weighted average of 9,243,508 shares, as compared with 8,376,345 in the year-earlier period. Analysis of Six Months Ended December 31, 1996 Compared to Six Months Ended December 31, 1995 On June 11, 1996, the Company entered into an exclusive Licensing Agreement with National Computer Systems, Inc. (NCS) transferring the development, production, and marketing rights of the Company's Intelligent Character Recognition (ICR) products to NCS. Largely as a result of the transfer of ICR operations to NCS, for the transition period the Company realized a 26% decrease in revenues compared to the corresponding period of the prior fiscal year. Expenses in the transition period decreased 8% and the operating loss increased 62% when compared with the corresponding period of the prior year. The Company began, in the quarter ended September 30, 1996, a project to customize its PRISM Fraud Detection System for a customer. Because the terms of the agreement have not been finalized, the Company is accounting for the development costs in accordance with SOP 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts," which provides that costs be deferred until delivery is made under the terms of an enforceable agreement. The Company executed its agreement on March 28, 1997 and made required deliveries. For the six months ended December 31, 1996, the Company deferred $364,000 of costs associated with this project. Revenues In 1996, the Company changed its accounting period to a calendar year from a fiscal year ending on June 30. The following table compares revenues for the transition period in 1996 with revenues for the comparable period of the preceding year, including and excluding revenues from ICR operations transferred to NCS: Total Total Total Revenues Revenues Revenues Six-Month Six-Month Six-Month Period Ended Period Ended Period Ended 12/31/95 12/31/96 12/31/96 Change Excluding ICR Change 1,196,000 $2,149,000 -44% $1,195,000 0% During the six months ended December 31, 1996, total revenues decreased $953,000 to $1,196,000 from $2,149,000 in the corresponding period of the prior fiscal year. Revenues in the year-earlier period included $954,000 of revenues associated with the ICR products that were licensed to NCS in June 1996. Software Licensing In the transition period, product-licensing revenues totaled $526,000, as compared with $902,000 in the prior period. The decrease in software licensing revenues reflects, primarily, the net of two effects: a decrease in ICR licensing revenues and an increase in licensing revenues relating to the Company's PRISM Fraud Detection product. During the transition period royalties paid by NCS relating to its sales of ICR products amounted to $68,000, a decrease of $704,000 in ICR revenues the Company recognized in the six months ended December 31, 1995. Revenues from the Company's PRISM product totaled $396,000 in the transition period, as compared with $150,000 in the corresponding period of the prior fiscal year. The growth of such revenues reflects additional PRISM licenses and increased license fees from existing licensees. Engineering Services During the six months ended December 31, 1996, revenues from engineering contracts totaled $606,000 as compared to $1,076,000 in the year-earlier period, including $182,000 of engineering revenues relating to the ICR products. Excluding engineering revenues relating to ICR products, revenues in the transition period decreased $470,000 compared with the corresponding period of the prior fiscal year. Revenues relating to customer-funded modifications of Nestor's Fraud Detection System totaled $380,000 in the transition period, as compared with $743,000 in the six months ended December 31, 1995. The Company's contracts with the Defense Advanced Research Projects Agency (DARPA) require engineering services rendered by the Company to develop a generic commercial application of the Company's technology to high-speed pattern recognition through the creation of an integrated circuit, associated circuit boards, and supporting development software. The Company has two contracts with DARPA. The first contract, which was signed in April 1990, is in the amount of $1,630,000; as of December 31, 1996, approximately $1,623,000 had been earned. The second contract, signed August 26, 1993, is in the amount of $776,000; as of September 30, 1996, approximately $773,000 had been earned. On September 1, 1995, the Company signed an agreement with the Jet Propulsion Laboratory (JPL) to develop a prototype sensor system designed for vehicular-traffic surveillance and detection. The contract, valued at approximately $597,000, was completed in December 1996. The terms of the DARPA and JPL contracts call for delivery of prototype products, but do not specify any subsequent purchasing or licensing provisions. During the six months ended December 31, 1996, the Company recognized revenues totaling $226,000 under its government contracts. In the year-earlier period such revenues totaled $97,000. Sales of Tangible Products The tangible products currently sold by the Company are based upon the Company's Ni1000 Recognition Accelerator Chip and the PCI4000 Recognition Accelerator Board, which are marketed along with development software that enables customers to develop high- speed recognition applications. Revenues from the Company's Ni1000 Development System totaled $64,000 in the transition period, as compared with $191,000 in the corresponding period of the prior fiscal year. The decrease in revenues is accounted for by a decrease in unit volume as the Company focused on its TrafficVision product, which incorporates the Ni1000 Recognition Accelerator Chip (see Investment in Product Development and Marketing, below). Operating Expenses Total operating expenses - consisting of engineering, research and development, sales and marketing, and general and administrative expenses - amounted to $2,115,000 in the six months ended December 31, 1996, as compared with $2,691,000 in the year-earlier period. Included in expenses for the six months ended December 31, 1995 are approximately $1,068,000 of expenses attributable to the ICR products, which were licensed to NCS in June 1996. Most of the expenses associated with the ICR products are no longer incurred by the Company as NCS hired most of the staff assigned to development, sales, and support of the ICR products. Offsetting the decrease in expenses attributable to the absence of the ICR products is the Company's increased spending on its PRISM Fraud Detection System, on its TrafficVision product, and on its newest product, Nestor InterSite, which is designed for use in internet and intranet environments. During the transition period the Company increased its spending on its PRISM Fraud Detection System by approximately $23,000 as compared with the year-earlier period. Spending on TrafficVision increased $358,000 from last year to this year, and the Company spent $167,000 on InterSite. Engineering Services Costs related to engineering services totaled $922,000 in the transition period, as compared to $805,000 in the corresponding period of the prior fiscal year. As a percentage of revenues, these costs increased from 75% last year to 152% this year reflecting additional costs incurred on projects that had been expected to conclude in the quarter ended September 30, 1996. Research and Development Research and development expenses totaled $294,000 in the six months ended December 31, 1996, as compared with $472,000 in the corresponding period of the prior fiscal year. The decrease in such costs was due, primarily, to the net of two effects: research and development costs relating to the ICR products totaled $350,000 in the year-earlier period, while there were no such costs in the transition period; and the Company began development in July 1996 of its Nestor InterSite product and such development costs totaled $137,000. Selling and Marketing The largest decrease in expenses was in selling and marketing. In the transition period selling and marketing expenses decreased $440,000 to $457,000 from $897,000 in the corresponding period of the prior fiscal year. The decrease in selling costs reflects the net of the absence of selling and marketing costs associated with the ICR products in the transition period and an increase in selling costs associated with the PRISM and TrafficVision products. ICR selling costs in the six months ended December 1995 totaled $637,000. General and Administrative General and administrative expenses totaled $432,000 in the transition period, as compared with $493,000 in the year-earlier period. The decrease in costs from last year to this year reflects the net of numerous account decreases and increases, with no single expense changing materially. Expenditures on Product Development and Marketing Revenues relating to the Company's PRISM and Fraud Detection System exceeded expenses by $71,000 in the six months ended December 31, 1996, The Company has installed its products at Mellon Bank, GE Consumer Credit Financial Services, BankOne, Europay International (an association of 700 banks in Europe). In September 1996, the Company signed a license agreement with Applied Communications, Inc. (ACI) enabling ACI to integrate and market Nestor's products with certain products of ACI. ACI provides authorization and transaction-processing software to nearly 500 financial institutions worldwide. The largest investment made by the Company was in its Intelligent Sensors Division, which is responsible for the development and marketing of the TrafficVision products, an outgrowth of work under the JPL contract. For the six months ended December 31, 1996, expenses of this group exceeded revenues by $437,000. The Company began development in July 1996 of a product for use in internet applications. Nestor InterSite enables customers to understand individual on-line customers as they visit Web sites and to dynamically present personalized content to those visitors Net Income Per Share During the transition period, the Company experienced a loss of $935,000, as compared with a loss of $723,000 in the corresponding period of the prior fiscal year. For the six months ended December 31, 1996, loss per share available for common stock was $0.13 per share, as compared with a loss per share of $0.11 in the corresponding period of the prior fiscal year. For the six months ended December 31, 1996, there were outstanding a weighted average of 8,689,031 shares, as compared with 7,719,371 in the year-earlier period. ITEM 7(a): Not applicable. 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 8, 1999 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 April 8, 1999 and Director /s/Charles Elbaum Co-Chairman of the Board April 8, 1999 and Director /s/David L. Fox President, Chief Executive April 8, 1999 Officer and Director /s/Herbert S. Meeker Secretary and Director April 8, 1999 /s/Sam Albert Director April 8, 1999 /s/John Guinan Director April 8, 1999 /s/Jeffrey Harvey Director April 8, 1999 /s/Thomas F. Hill Director April 8, 1999 /s/Bruce Schnitzer Director April 8, 1999 CONSOLIDATED FINANCIAL STATEMENTS FORM 10-K December 31, 1998 NESTOR, INC. Part II Item 8 CONTENTS Independent Auditor's Report Statement No. Consolidated Balance Sheets 1 December 31, 1998 and 1997 Consolidated Statements of Operations - For the Years Ended December 31, 1998 and 1997, For the Six Months Ended December 31, 1996 and For the Years Ended June 30, 1996 2 Consolidated Statements of Cash Flows - For the Years Ended December 31, 1998 and 1997 For the Six Months Ended December 31, 1996 and For the Year Ended June 30, 1996 3 Consolidated Statements of Stockholders' Equity - For the Years Ended December 31, 1998 and 1997 For the Six Months Ended December 31, 1996 and For the Years Ended June 30, 1996 4 Notes to Consolidated Financial Statements 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, 1998 and 1997, and the related consolidated statements of operations, cash flows and stockholders' equity for the years ended December 31, 1998 and 1997 and the period July 1, 1996 to December 31, 1996. 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 generally accepted auditing standards. 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 1998 and 1997 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Nestor, Inc. at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for the years ended December 31, 1998 and 1997 and the period July 1, 1996 to December 31, 1996, in conformity with generally accepted accounting principles. 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 17, 1999 (except for Note 23 as to which the date is March 25, 1999) INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders of Nestor, Inc. Providence, Rhode Island We have audited the consolidated statements of operations, cash flows and stockholders' equity of Nestor, Inc. for the year ended June 30, 1996. Our audit 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 audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated statements of operations, cash flows and stockholders equity are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated statements of operations, cash flows, and stockholders equity. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated statements of operations, cash flows, and stockholders equity. We believe that our audits of the consolidated statements of operations, cash flows and stockholders equity provide a reasonable basis for our opinion. In our opinion, the consolidated statements of operations, cash flows, and stockholder's equity present fairly, in all material respects, the results of operations, cash flows, and stockholders equity of Nestor, Inc. for the year ended June 30, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. GASSMAN, REBHUN & CO., P.C. New York, New York September 6, 1996 NESTOR, INC. Consolidated Balance Sheets
December 31, ASSETS 1998 1997 Current assets: Cash and cash equivalents $ 1,175,183 $ 386,639 Accounts receivable, net of allowance for doubtful accounts 512,748 557,212 Unbilled contract revenue 118,209 298,803 Other current assets 329,961 232,492 Total current assets 2,136,101 1,475,146 Property and equipment at cost - net of accumulated depreciation 368,525 261,463 Deferred development costs 80,000 574,752 Intangible assets - net of accumulated amortization --- 295,887 Other assets 6,963 5,783 Total Assets $ 2,591,589 $ 2,613,031 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable and accrued expenses $ 1,150,604 $ 920,833 Deferred income 434,036 408,232 Total current liabilities 1,584,640 1,329,065 Noncurrent liabilities: Long term obligations under capital leases 22,618 10,220 Total liabilities 1,607,258 1,339,285 Series E, F, G and H redeemable convertible preferred stock 4,846 shares at December 31, 1997 (liquidation value $1,000 per share plus accrued dividends) --- 5,792,787 Commitments and contingencies --- --- Stockholders' Equity (Deficit): Preferred stock, $1.00 par value, authorized 10,000,000 shares; issued and outstanding: Series B - 365,000 shares at December 31, 1998 And 1,445,000 shares at December 31, 1997 365,000 1,445,000 Series D - 0 shares at December 31, 1998 and 170,871 shares at December 31, 1997 --- 265,347 Common stock, $.01 par value, authorized 30,000,000 shares; issued and outstanding: 17,479,327 shares at December 31, 1998 and 9,403,987 shares at December 31, 1997 174,793 94,040 Warrants and options 630,467 523,984 Additional paid-in capital 24,504,556 12,579,920 Retained (deficit) (24,690,485) (19,427,332) Total stockholders' equity (deficit) 984,331 (4,519,041) Total Liabilities and Stockholders' Equity (Deficit) $ 2,591,589 $ 2,613,031 The Notes to the Financial Statements are an integral part of this statement.
NESTOR, INC. Consolidated Statements of Operations
Six Months Ended Year Ended Years Ended December 31, December 31, June 30, 1998 1997 1996 1996 Revenue: Software licensing $ 1,352,071 $ 4,390,479 $ 526,353 $ 2,825,600 Engineering services 746,007 1,055,459 605,776 2,378,135 Tangible product sales 143,298 235,138 63,775 257,845 Total revenue 2,241,376 5,681,076 1,195,904 5,461,580 Operating Expenses: Engineering services 2,066,558 1,151,147 922,325 1,833,531 Tangible product costs 54,010 134,305 8,978 32,189 Research and development 2,112,746 1,498,181 294,136 823,000 Selling and marketing 1,831,697 1,986,340 457,281 1,764,585 General and administrative 1,413,340 1,207,088 432,301 1,035,535 Total operating expenses 7,478,351 5,977,061 2,115,021 5,488,840 Loss from operations (5,236,975) (295,985) (919,117) (27,260) Other income (expense) - net (26,178) 31,321 (16,220) 39,950 Income (loss) before income taxes (5,263,153) (264,664) (935,337) 12,690 Income taxes --- 30,000 --- --- Net Income (Loss) $(5,263,153) $ (294,664) $ (935,337) $ 12,690 Loss Per Share: Net Income (Loss) $(5,263,153) $ (294,664) $ (935,337) $ 12,690 Dividends accrued on preferred stock 151,396 447,191 201,094 261,210 Net Loss Available for Common Stock $(5,414,549) $ (741,855) $(1,136,431) $ (248,520) Loss Per Share: Basic and diluted $ (0.36) $ (0.08) $ (0.13) $ (0.03) Shares Used in Computing Loss Per Share: Basic and diluted 15,249,932 9,243,508 8,689,031 7,847,510 The Notes to the Financial Statements are an integral part of this statement.
NESTOR, INC. Consolidated Statements of Cash Flows
Six Months Ended Year Ended Years Ended December 31, December 31, June 30, 1998 1997 1996 1996 Cash flows from operating activities: Net income (loss) $(5,263,153) $(294,664) $ (935,337) $ 12,690 Adjustments to reconcile net income (loss) to net cash used by operating activities: Write-down for impairment loss 790,641 --- --- --- Depreciation and amortization 114,810 194,311 45,328 104,559 Loss on disposal of fixed assets --- 3,573 --- 4,346 Expenses charged to operations relating to options, warrants and capital transactions 106,483 161,684 42,500 178,375 Discount on payment of vendor obligation --- (100,000) --- --- Changes in assets and liabilities: (Increase) decrease in accounts receivable 44,464 451,937 (414,839) 67,424 (Increase) decrease in unbilled contract revenue 180,594 (171,858) 155,991 (74,584) (Increase) in deferred development costs --- (210,347) (364,405) --- (Increase) decrease in other assets (98,649) 41,635 (45,877) (99,025) (Decrease) increase in accounts payable and accrued expenses 199,750 (63,845) (83,593) (568,309) (Decrease) increase in deferred income 25,804 (361,071) 252,300 796 Net cash used by operating activities (3,899,256) (348,645) (1,347,932) (373,728) Cash flows from investing activities: Purchase of property and equipment (132,209) (88,622) (71,390) (57,531) Proceeds from the disposal of fixed assets --- --- --- 85,000 Net cash provided (used) By investing activities (132,209) (88,622) (71,390) 27,469 Cash flows from financing activities: Repayment of obligations under capital leases (47,246) (11,913) (5,338) (7,924) Proceeds from notes payable 250,000 --- --- 300,000 Repayment of notes payable (250,000) --- --- --- Rights offering expense --- --- --- (136,421) Redemption of Preferred Series D Stock (41,424) --- --- --- Proceeds from issuance of common stock - net 4,977,749 96,975 185,800 99,510 Proceeds from issuance of preferred stock - net --- --- --- 1,651,823 Payments of dividends on preferred stock (69,070) (35,613) --- --- Net cash provided by financing activities 4,820,009 49,449 180,462 1,906,988 Net change in cash and cash equivalents 788,544 (387,818) (1,238,860) 1,560,729 Cash and cash equivalents- beginning of period 386,639 774,457 2,013,317 452,588 Cash and cash equivalents- end of period $1,175,183 $ 386,639 $ 774,457 $ 2,013,317 Supplemental cash flows information: Interest paid $ 20,350 $ 3,598 $ 3,227 $ 4,372 Income taxes paid $ 37,500 $ --- $ --- $ --- Significant non-cash transactions are described in Notes 7, 10, 12 and 19
Nestor, Inc. Consolidated Statement of Stockholders' Equity
Common Stock Preferred Stock Additional Retained Stock Shares Amount Shares Amount Paid-in Capital (Deficit) Warrants Total Balance at 6/30/95 7,606,710 $ 76,067 2,992,064 $ 2,992,064 $ 11,103,449 $(18,210,021) $375,000 $(3,663,441) Issuance of Common Stock 177,998 1,780 --- --- 175,928 --- --- 177,708 Issuance of Preferred Stock --- --- 210,549 315,824 (10,000) --- --- 305,824 Conversion of Preferred Stock to Common Stock 490,878 4,909 (490,878) (503,817) 498,908 --- --- --- Dividends on Preferred Stock Series D paid in Common Stock 5,355 53 --- --- 13,495 --- --- 13,548 Dividends accrued on Preferred Stock --- --- --- --- (274,819) --- --- (274,819) Expenses incurred in reduction of exercise price of outstanding warrants --- --- --- --- 131,250 --- --- 131,250 Costs incurred in connection with August 1995 securities registration --- --- --- --- (136,421) --- --- (136,421) Income for the year ended June 30, 1996 --- --- --- --- --- 12,690 --- 12,690 Balance at 6/30/96 8,280,941 $ 82,809 2,711,735 $ 2,804,071 $ 11,501,790 $(18,197,331) $375,000 $(3,433,661) Issuance of Common Stock 190,200 1,902 --- --- 183,898 --- --- 185,800 Conversion of Preferred Stock to Common Stock 445,000 4,450 (445,000) (447,500) 443,050 --- --- --- Dividends accrued on Preferred Stock Series D --- --- --- 9,723 (9,723) --- --- --- Accretion of value of warrants --- --- --- --- --- --- 42,500 42,500 Dividends accrued on Redeemable Convertible Preferred Stock --- --- --- --- (191,371) --- --- (191,371) Loss for the six months ended December 31, 1996 --- --- --- --- --- (935,337) --- (935,337) Balance at 12/31/96 8,916,141 $ 89,161 2,266,735 $ 2,366,294 $ 11,927,644 $(19,132,668) $417,500 $(4,332,069) Issuance of Common Stock 279,592 2,796 --- --- 472,769 --- --- 475,565 Conversion of Preferred Stock to Common Stock 198,800 1,988 (198,800) (203,200) 201,212 --- --- --- Dividends on Preferred Stock Series D paid in Common Stock and cash 9,454 95 --- (18,381) 18,222 --- --- (64) Repurchase of Preferred Stock Series A --- --- (452,064) (452,064) 352,063 --- --- (100,001) Dividend accrued on Preferred Stock Series D --- --- --- 17,698 (17,698) --- --- --- Dividends accrued on Redeemable Convertible Preferred Stock --- --- --- --- (429,492) --- --- (429,492) Issuance of non-qualified options --- --- --- --- 55,200 --- --- 55,200 Accretion of value of warrants --- --- --- --- --- --- 106,484 106,484 Loss for the year ended December 31, 1997 --- --- --- --- --- (294,664) --- (294,664) Balance at 12/31/97 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 12/31/98 17,479,327 $174,793 365,000 $ 365,000 $ 24,504,556 $(24,690,485) $630,467 $ 984,331 The Notes to the Financial Statements are an integral part of this statement.
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., Nestor Traffic Systems, Inc. ("NTS"), formerly known as Nestor IS, Inc., and Nestor Interactive, Inc. ("Interactive"). NTS and Interactive are wholly owned subsidiaries formed January 1, 1997. 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. B. Product and patent development costs The costs of development of the Company's software which consist primarily of labor and outside consulting and which 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 would be on a straight-line basis over the shorter of the estimated economic life, or statutory life, of the patent. At December 31, 1998 and 1997, there were no capitalized patent-development costs. C. Depreciation and amortization Depreciable assets are recorded at cost. Depreciation is provided on the straight-line method over the estimated useful lives of the respective assets. Maintenance and repairs are expensed as incurred. Major renewals and betterments are capitalized. D. 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. Prior years have not been restated. 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 has been recognized as follows: Since January 1, 1998: 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. Before January 1, 1998: Revenue from software licensing is recognized upon delivery provided that no significant vendor and post-contract support obligations remain outstanding and collection of the resulting receivable is deemed probable. Where there are insignificant post-contract support obligations and/or warranties remaining at the time of delivery, the Company recognizes revenue and accrues the estimated cost of fulfilling such obligations or warranties. 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. In all periods: 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 with progress-to-completion measured based upon labor costs incurred. Training revenue is recognized upon the completion of training sessions with the customer. Adoption of SOP 97-2 had an insignificant impact on net loss for the year ended December 31, 1998. E. Cash equivalents For the purpose of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of 90 days or less to be cash equivalents. F. Accounting for issuance and exercise of warrants and options to purchase Common Stock The Company records no expense upon the issuance of warrants and options issued at fair market value. For warrants and options issued at an exercise price below fair market value, the Company records an expense equal to the difference between the market value of the underlying shares of Common Stock and the exercise price of such options or warrants. When the Company induces warrant or option holders to exercise at a price lower than the original exercise price, the Company recognizes an expense equal to the fair value of the securities issued less the proceeds received for the securities, but not more than the reduction in the exercise price. G. 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 consequence, 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. H. Inventory Inventory, consisting primarily of finished goods, is valued at the lower of cost or market on the first-in, first-out basis. Inventories, valued at $231,613 and $144,875 at December 31, 1998 and 1997, respectively, are included as "Other current assets" on the Consolidated Balance Sheets. I. 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. J. Change in Fiscal Year The Company changed its fiscal year from June 30 to December 31 effective December 31, 1996. The results for the six month period ended December 31, 1996 have been presented in the main body of the financial statements. K. Change in Presentation In order to conform to the December 31, 1998 presentation, certain balances at December 31, 1997, have been reclassified. Note 2 - Comparative Financial Information: The following financial information for the six months ended December 31, 1995 and the year ended December 31, 1996, is unaudited and is being presented for comparative purposes: Year-Ended Six Months Ended December 31, 1996 December 31, 1995 (Unaudited) (Unaudited) Total revenues $4,508,397 $ 2,149,088 Loss from operations (403,741) (542,385) Net loss (199,420) (723,227) Net loss per share - basic and diluted $ (0.09) $ (0.09) Note 3 - Income (loss) per share: The Company reports its income (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. "Fully diluted" EPS has been replaced by "diluted" EPS. Diluted EPS is computed giving effect to common stock equivalents and other dilutive securities, unless the computation results in anti-dilution. Note 4 - Accounts receivable, net of allowance for doubtful accounts: December 31, 1998 1997 Trade accounts receivable $543,048 $ 711,766 Allowance for doubtful accounts (30,300) (154,554) Accounts receivable, net of allowance for doubtful accounts $512,748 $ 557,212 Note 5 - 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. For the six months ended December 31, 1996, the Company had deferred $364,000 of costs associated with this project. During 1997, an additional $211,000 of such costs were capitalized in connection with engineering and installation of the project. Management believed that these costs, which are subject to a binding contract entered into upon delivery of the software on March 28, 1997, would be fully recovered over the five year term of the aforementioned contract. Although revenue had not yet been earned under this contract, the Company began to amortize the related deferred costs in June 1998. In December 1998 initial contract revenues were recognized. In view of the level of revenue generated by this contract, 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 at December 31, 1998. The residual deferred costs will be amortized on a straight-line basis over the remaining term of the contract. Note 6 - Property and equipment at cost - net: Useful Life in Years or December 31, Lease Term 1998 1997 Leasehold improvements $ --- $ 22,945 Lease Term Office furniture and equipment 234,706 199,254 5 - 7 Leased computer equipment under capital leases 113,893 46,730 5 Computer equipment 1,344,244 1,238,913 3 - 5 $1,692,843 $1,507,842 Less: Accumulated depreciation and amortization 1,324,318 1,246,379 $ 368,525 $ 261,463 Depreciation and amortization expense on the above assets of $114,810, $95,682, $45,327, and $104,559 was recorded for the years ended December 31, 1998 and 1997, for the six months ended December 31, 1996, and for the year ended June 30, 1996, respectively. Note 7 - 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 has ceased further investment in the Interactive subsidiary (see Note 1) and future realization of the asset is uncertain, the remaining value of this asset was written off in November 1998. Note 8 - Accounts payable and accrued expenses: Accounts payable and accrued expenses consists of the following: December 31, 1998 1997 Trade accounts payable $ 400,900 $ 316,670 Accrued salaries 279,929 333,046 Other accrued expenses 469,775 271,117 $1,150,604 $ 920,833 Note 9 - Lines of credit: On July 29, 1997 Nestor, Inc. entered into a $200,000 Revolving Line of Credit with a bank. In March 1998, the Line was increased to $500,000. The interest rate was equal to the prime rate plus 1.5%, and the Line was secured by the tangible assets of Nestor, Inc. The Line was terminated in September 1998. On March 25, 1998, TSAI granted the Company a short-term note in contemplation of the TSAI stock purchase (Note 12). This note was surrendered on April 29, 1998. On March 24, 1999, a new Line of Credit was established with TSAI (Note 23). Note 10 - Redeemable convertible preferred stock: On March 31, 1998, the Company and Wand Partners, owners of the outstanding redeemable convertible preferred stock, agreed to modify certain terms and conditions governing the stock. Wand Partners agreed to release the Company from mandatory redemption in exchange for the Company's agreement to increase the dividend rate by one percent per annum beginning on July 1, 2000. On April 29, 1998, Wand Partners converted all of its redeemable convertible preferred stock into common stock (see Note 12). The Company was originally required to redeem all of the following series of convertible preferred stock on or before August 1, 2004. Accordingly, this preferred stock subject to mandatory redemption was presented separately outside of permanent stockholders' equity in the accompanying financial statements. December 31, 1998 1997 Series E, par value $1.00 per share, 1,444 shares outstanding and $305,577 of accumulated dividends at December 31, 1997. $ --- $ 1,749,577 Series F, par value $1.00 per share, 599 shares outstanding and $95,821 of accumulated dividends at December 31, 1997. --- 694,821 Series G, par value $1.00 per share, 777 shares outstanding and $116,650 of accumulated dividends at December 31, 1997. --- 893,650 Series H, par value $1.00 per share, 2,026 shares outstanding and $428,739 of accumulated dividends at December 31, 1997. --- 2,454,739 TOTAL $ --- $5,792,787 The redeemable convertible preferred stock originally accrued and accumulated dividends at rates of seven percent on Series E and H and nine percent on Series F and G, 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 and $35,613 in 1997 on the redeemable convertible preferred stock. Note 11 - Convertible Preferred stock: In June 1997 the Company repurchased from Sligos S.A. all of the outstanding shares of the Series A Preferred Stock. See Note 19, Termination of License Agreement. Series A Preferred Stock was convertible at any time into one fully paid and non-assessable share of Common Stock. Series A Preferred had the same dividend rights as shares of Common Stock but carried no voting rights. Each share of Series A Preferred had the right to receive in liquidation $2.00 before any distribution was made on Common Stock or on any other class of stock ranking junior to Series A. 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 in liquidation $1.00 before any distribution is made to holders of the Common Stock. The liquidation value of Series B Preferred was $365,000, and $1,445,000, at December 31, 1998 and 1997, 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 Series D Preferred had the right to receive annual dividends at the rate of seven percent (7%) of the stated value per share ($1.50), paid in cash or in shares of Common Stock at the option of the Company. On June 30, 1997, the Company paid stock dividends on the Series D Preferred totaling $18,381. The Company had the right, after June 1, 1996, to redeem in cash the Series D Preferred, in whole or in part from time to time, at the stated value per share plus accrued dividends. The liquidation value of Series D Preferred was $265,347 at December 31, 1997. 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. After paying dividends of $17,941 on June 30, 1998, the Company reclassified the unconverted Series D balance to accounts payable and accrued expenses where $36,349 remains unpaid at December 31, 1998. Note 12- Common 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. 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 (Note 10) into common stock. Additionally, a conversion offer to Series B Preferred stockholders and call on Series D preferred shares, resulted in 979,200 and 143,155 shares, respectively, of common stock issued as of June 30, 1998 (Note 11). Note 13- 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 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 are exercisable for up to ten years from the date of grant, although all 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") which is first applicable to the Company's fiscal year ended June 30, 1996. 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, 1998 and 1997, for the six months ended December 31, 1996 and for the fiscal year ended June 30, 1996:
Six Months Ended Year Ended Years Ended December 31, December 31, June 30, 1998 1997 1996 1996 Weighted Weighted Weighted Weighted Av. Ex. Av. Ex. Av. Ex. Av. Ex. Shares Price Shares Price Shares Price Shares Price Outstanding beginning of year 2,214,000 1.58 1,781,500 1.50 1,356,000 1.03 1,399,000 1.80 Granted 454,124 .99 484,000 1.81 612,000 2.38 1,406,000 1.04 Exercised 31,250 1.09 46,875 1.00 186,500 0.98 100,500 1.09 Canceled 1,057,750 1.88 4,625 1.67 --- --- 1,348,500 1.83 Outstanding end of year 1,579,124 1.22 2,214,000 1.58 1,781,500 1.50 1,356,000 1.03 Options exercisable at year end 1,102,846 1.22 1,470,250 1.39 1,101,875 1.22 1,023,500 1.00 Weighted average Fair value of Options granted During the year $ 0.71 $ 1.44
The following table presents weighted average price and life information about significant option groups outstanding at December 31, 1998.
Options Outstanding Options Exercisable Weighted Average Weighted Weighted Number Remaining Average Number Averaged Range of Outstanding Contractual Exercise Exercisable Exercisable Exercise Prices at 12/31/98 Life (Years) Price at 12/31/98 Price $ .87- $1.00 1,086,374 2.79 $0.90 816,034 $0.97 $ 1.50- $2.00 288,250 3.48 1.55 160,688 1.55 $ 2.09- $2.44 143,000 3.03 2.26 88,250 2.27 $ 2.81- $2.94 61,500 3.20 2.76 37,875 2.81 1,579,124 2.96 $1.22 1,102,846 $1.22
The following are the pro forma net loss and net loss per share for the years ended December 31, 1998 and 1997, for the six months ended December 31, 1996, and for the year ended June 30, 1996, as if the compensation cost for the option plan had been determined based on the fair value at the grant date for grants in those periods and reflected in the financial statements:
Year Ended Year Ended Six Months Ended Year Ended December 31, 1998 December 31, 1997 December 31, 1996 June 30, 1996 As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma Net Income (loss) $(5,263,153) $(4,710,218) $(294,664) $ (876,280) $(935,337) $(1,277,841) $ 12,690 $(633,262) Net (loss) per share $ (0.36) $ (0.32) $ (0.08) $ (0.14) $ (0.13) $ (0.17) $ (0.03) $ (0.11)
The effects on the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and the year ended June 30, 1996, 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, 1998 and the Company expects to grant additional options in future years. Because FAS No. 123 is first applicable to the Company's fiscal year ended June 30, 1996, the full effects on pro forma earnings will not be felt until 1998. The fair value of each option grant was estimated using the Black-Scholes model with risk-free interest rates on the date of grant that 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 .815 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:
Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996 Officers --- --- 10,000 Others 5,000,580 2,709,089 2,826,239 Eligible, End of Year for Exercise Currently 5,000,580 2,709,089 2,836,239 Warrants issued 2,500,000 --- --- Low exercise price $ 3.00 $ --- $ --- High exercise price $ 3.00 $ --- $ ---
The warrants outstanding as of December 31, 1998, 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. 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, $106,000 and $42,000 for the years and six months ended December 31, 1998, 1997 and 1996, respectively. Also during the year ended June 30, 1996, the Company issued to Wand Partners, Inc. 700,000 ten-year warrants to purchase shares of the Common Stock of the Company at $1.00 per share. The Company recorded a charge of $131,250 representing the difference between the market value of the underlying Common Stock of the Company and the aggregate exercise price of such warrants during the fiscal year ended June 1996. Note 14 - Segment Information: A. Description of reportable segments Nestor, Inc. has three reportable segments: Financial Solutions, Traffic Systems and Internet products. While the Company always differentiated these segments internally, on January 1, 1997 the latter two were separated from Nestor, Inc. into distinct subsidiaries (see Note 1), leaving Financial Solutions within the parent company. The reportable segments are each managed separately because they design, develop, market and support different products. 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 provides 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. "All Other" revenues consist primarily of royalties (Note 20) and, in 1997, include $480,000 relating to the termination of a license agreement (Note 19). Segment information for the year ended June 30, 1996 has not been presented because the Company did not account for the segments separately at that time.
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 Year Ended Dec. 31, 1997: Revenues $ 4,752,000 $ 328,000 $ --- $ 601,000 $ 5,681,000 Depreciation and amortization expense 50,000 19,000 106,000 19,000 194,000 Segment profit (loss) 1,300,000 (1,492,000) (784,000) 711,000 (265,000) Segment assets 1,520,000 225,000 355,000 513,000 2,613,000 Expenditures for long-lived assets 42,000 14,000 31,000 2,000 89,000 Six Months Ended Dec. 31, 1996: Revenues $ 776,000 $ 335,000 $ --- $ 85,000 $ 1,196,000 Depreciation and amortization expense 23,000 8,000 1,000 13,000 45,000 Segment profit (loss) (194,000) (638,000) (214,000) 111,000 (935,000) Segment assets 1,722,000 182,000 11,000 903,000 2,818,000 Expenditures for long-lived assets 31,000 23,000 8,000 9,000 71,000
D. Geographic Information Revenues are attributed to countries based on the location of customers. All long-lived assets are located in the Unites States.
Six Months Ended Year Ended Years Ended December 31, December 31, June 30, 1998 1997 1996 1996 U.S.A. $ 1,918,951 $ 3,391,825 $ 1,085,050 $ 4,071,781 France --- $ 480,899 $ 30,000 $ 65,085 Belgium 212,097 903,662 42,000 727,375 Germany 17,460 --- --- 173,877 Japan 55,333 531,590 14,094 36,424 Canada 27,000 223,000 --- 41,710 Singapore 10,535 --- --- 65,530 All other countries --- 150,100 24,760 279,798 $ 2,241,376 $ 5,681,076 $ 1,195,904 $ 5,461,580
E. Revenues from Major Customers All revenues presented are derived from the Company's Financial Solutions segment with the exception of Customers E and H, which relate to the Traffic Systems segment and the "All Other Category" (Note 20), respectively.
Six Months Ended Year Ended Years Ended December 31, December 31, June 30, 1998 1997 1996 1996 Customer A $ 620,732 $ 2,216,375 $ --- $ --- Customer B --- 903,662 --- 727,375 Customer C 445,115 --- 215,400 --- Customer D 302,979 --- 153,750 --- Customer E --- --- 225,994 --- Customer F --- --- 185,000 --- Customer G --- --- 132,382 --- Customer H --- --- --- 1,614,510
Note 15- Other income (expense) - net: Other income (expense) as reflected in the consolidated statements of operations consists of the following:
Six Months Year Ended Ended Years Ended December 31, December 31, June 30, 1998 1997 1996 1996 Interest expense $ (20,350) $ (3,598) $ (3,227) $ (51,574) Expense relating to financing operations (106,483) (106,484) (42,500) (131,250) Net gain on sale of tangible and intangible assets (See Note 20) --- --- --- 213,185 Other - net 100,655 141,403 29,507 9,589 Other Income (Expense) - Net $ (26,178) $ 31,321 $ (16,220) $ 39,950
Note 16- 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. The components of the provision (benefit) for income taxes are: December 31, December 31, 1998 1997 Current: Federal $ --- $ 30,000 State --- --- Deferred: Federal --- --- State --- --- --- --- Total Income Taxes $ --- $ 30,000 Significant components of the Company's deferred tax liabilities and assets as of December 31, 1998 and 1997 are as follows: December 31, December 31, 1998 1997 Deferred tax liabilities: Deferred development costs $ 32,000 $ --- Accrued expenses --- 43,000 Total deferred tax liabilities $ 32,000 43,000 Deferred tax assets: Accounts receivable 12,000 62,000 Accrued expenses 246,000 205,000 Deferred income 16,000 60,000 Tax credits 17,000 30,000 Net Operating Loss 8,619,000 6,563,000 Total deferred tax assets 8,910,000 6,920,000 Valuation allowance (8,878,000) (6,877,000) Net deferred tax assets 32,000 43,000 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. Management has established an allowance equal to the value of the net deferred tax assets due to the Company's history of net losses. The realization of the deferred tax assets is not assured because of the potential for future losses and potential limitations on the Company's ability to utilize its net operating loss carryforwards due to certain provisions contained in Section 382 of the Internal Revenue Code. A reconciliation of the provision for income taxes to the amount computed using the Federal statutory tax rates consists of the following:
Six Months Year Ended Ended Years Ended Dec. 31, Dec. 31, June 30, 1998 1997 1996 1996 Income (Loss) Before Taxes $(5,263,000) $(265,000) $ (935,000) $ 13,000 Tax at statutory rate of 34% $(1,789,000) $(101,000) $ (303,000) $ 4,000 State income tax (net of federal benefit) (313,000) (19,000) (53,000) 1,000 Effect of permanent differences 101,000 (36,000) 3,000 7,000 Valuation Allowance 2,001,000 186,000 353,000 (12,000) Income Tax Expense $ --- $ 30,000 $ --- $ ---
The Company and its subsidiaries have available at December 31, 1998, $23,290,000 and $11,792,000 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 1999. Note 17- 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, 1998 and 1997, the six months ended December 31, 1996, and for the year ended June 30, 1996, the Company recorded an expense for Baer, Marks & Upham of $15,600, $14,400, $7,200 and $14,440, respectively. Included in Accounts payable and accrued expenses at December 31, 1998 and 1997, are $6,726 and $4,325, respectively, due Baer, Marks & Upham. 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, 1998 and 1997, the six months ended December 31, 1996, and for the year ended June 30, 1996, the Company recorded an expense for Wand Partners, Inc. of $47,770, $49,479, $25,060 and $46,076, respectively. During 1997 the Company granted Mr. Schnitzer, as a director of the Company, a non- qualified stock option for a total of 5,000 shares and recognized an expense of $6,900. Additionally, during 1998 and 1997, the Company paid Wand Partners dividends totaling $69,046 and $35,613, respectively, on the redeemable preferred stock held by Wand. Included in Accounts payable and accrued expenses at December 31, 1998 and 1997 are $63,738 and $23,301, respectively, due Wand Partners, Inc. Thomas F. Hill, who became a director of the Company in August 1994, is President of Thomas F. Hill, Inc., a consulting firm that the Company uses for marketing consulting. During 1997 the Company granted Mr. Hill, as a director of the Company, a non-qualified stock option for a total of 5,000 shares and recognized an expense of $6,900. Thomas D. Halket, who became an officer of the Company in January 1993, is a partner in the law firm of Halket & Pitegoff LLP, which the Company uses as outside counsel. For the years ended December 31, 1998 and 1997, the six months ended December 31, 1996, and for the year ended June 30, 1996, the Company recorded an expense for Halket & Pitegoff LLP of $80,039, $100,961, $65,425, and $144,176, respectively. Included in Accounts payable and accrued expenses at December 31, 1998 and 1997 are $8,328 and $67, respectively, due Halket & Pitegoff LLP. During 1997 the Company issued non-qualified options to Mr. Sam Albert, Dr. Leon Cooper, Dr. Charles Elbaum, and Mr. Jeffrey Harvey as directors of the Company. Each option was for 5,000 shares and the Company recognized an expense of $27,600. During 1998, TSAI, the parent company of Applied Communications, Inc. (ACI), became a significant shareholder of the Company (Note 12). For the year ended December 31, 1998, the Company recorded revenues of $620,730 from ACI. At December 31, 1998, accounts receivable included $157,808 due from ACI and unbilled was $52,934. Also at December 31, 1998, deferred income included $237,500 from ACI. Further related party transactions with TSAI are discussed in Notes 9, 13 and 23. Note 18- Commitments and contingencies: The Company leases 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 $193,953, $188,936, $47,989 and $171,928 was charged to operations for the years ended December 31, 1998 and 1997, for the six months ended December 31, 1996 and for the year ended June 30, 1996, respectively. 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 17 - Related party transactions). The Company had placed purchase orders, including an end-of-life order, totaling $877,500 with Intel Corporation for a supply of the Ni1000 Recognition Accelerator Chips. During January 1999, the Company took delivery of $195,000 of the chips and cancelled the remaining order of $682,500 since the current demand for the product no longer warranted such a purchase and future third-party hardware is expected to provide adequate capacity to operate the Company's software. The Company entered into an agreement on September 25, 1997, for the modification of one of the components of the TrafficVision product. Nestor agreed to pay Zeller Research, Ltd. $75,000 (of which $30,000 was paid in 1998) for engineering, which is expected to be completed in 1999, and to purchase 100 units of the modified component at a total cost of up to $53,000. The aggregate minimum payments due over the remaining term of the above agreements is as follows: December 31, 1999 $ 528,000 December 31, 2000 235,000 December 31, 2001 239,875 December 31, 2002 246,375 December 31, 2003 92,000 Thereafter 40,000 $ 1,381,250 Note 19- Termination of license agreement: In December 1994, Sligos agreed to convert $200,000 of its prepayment into equity and the Company agreed to refund to Sligos its prepayments of royalties and engineering fees under its license agreement with the Company, which was dated October 16, 1990. At December 31, 1996, such long-term portion of deferred income remaining on the books of the Company amounted to $430,899 after giving effect to the application of $200,000 of deferred income to the purchase by Sligos of 100,000 shares of Series A Preferred Stock, $30,000 refunded by the Company to Sligos, and the reclassification of $275,000 to Other current liabilities. In June 1997 the Company and Sligos terminated their License Agreement. Pursuant to the termination agreement, the Company paid Sligos in July 1997, $225,000 in full settlement of its obligation to Sligos, which had been classified as a current liability on the Company's balance sheet, and of the repurchase from Sligos of 452,000 shares of Company's Series A Preferred Stock. The Company allocated $125,000 of the payment to the settlement of its current liability to Sligos and consequently recorded other income of $100,000 as discount on the obligation to Sligos. The Company allocated the remaining $100,000 of the payment to the repurchase of its Series A Preferred Stock and, accordingly, reclassified $352,000 to additional paid-in capital. The Company also eliminated the long-term deferred income related to Sligos prepayments (which were received in October 1990) and recorded software licensing revenues of $480,000. Note 20- Significant transactions: On June 11, 1996, the Company entered into an exclusive Licensing Agreement and an Asset Purchase Agreement with National Computer Systems, Inc. (NCS) transferring the development, production, and marketing rights of the Company's Intelligent Character Recognition (ICR) products to NCS. The Company received $1,400,000 as an initial license fee pursuant to the Licensing Agreement, and has the right to receive royalties on future sales of the products by NCS. The minimum annual royalty to maintain exclusive rights was $160,000 and $200,000 for the years ended June 30, 1997 and 1998, respectively. NCS lost its exclusive rights under the contract on June 30, 1998 upon failure to meet minimum royalty obligations. Royalties are computed as 10% of the ICR product sales. The Company recognized $32,000 and $120,000 of revenue under this license agreement in calendar 1998 and 1997. The initial license fee was included in software licensing revenue in the year-ended June 30, 1996. The Asset Purchase Agreement transferred tangible and intangible assets used exclusively in the ICR business to NCS for $300,000. The net gain on the sale of these assets was recognized as Other income in the year-ended June 30, 1996. Note 21- New accounting standards: Comprehensive Income: In 1998, the Company adopted Financial Accounting Standard 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the Company's comprehensive income does not differ from net income. Therefore, adoption of this Statement has had no impact on the Company's results of operations. Segment Reporting: Effective December 31, 1998, the Company adopted the Financial Accounting Standards Board's Statement of Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("Statement 131"). Statement 131 superseded FASB Statement No. 14, Financial Reporting for Segments of a Business Enterprise. Statement 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement 131 did not affect results of operations or financial position, but did require the disclosure of segment information. See Note 14. Note 22- Litigation: On October 6, 1998, HNC Software Corp. ("HNC"), a significant competitor of the Company's in the field of Financial Services, claimed rights to a patent entitled "Fraud Detection Using Predictive Modeling" and began advising prospective customers of the Company of the patent. Upon review of the claimed patent and consideration of prior actions taken by HNC, the Company initiated a lawsuit to protect its interest in the marketplace. The suit, filed in the United States District Court in Providence, RI on November 25, 1998, makes numerous claims including 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. The suit seeks various damages, including lost profits and treble damages. Costs associated with the suit are being expensed as incurred. Although the Company believes that it will prevail, there can be no assurance as to the outcome of this suit, or any potential countersuit. Any conclusion of this litigation in a manner adverse to the Company may have an adverse effect on its future financial condition and results of operations. Note 23- Subsequent Events: 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. Principal payments are due in twelve equal installments beginning March 1, 2001. Interest on the loan is based on the prime interest rate plus 1% and payments are due quarterly in arrears beginning July 10, 1999. The line may be reduced to $500,000 if the Company's equity becomes negative or increased up to $4,000,000 if certain financial requirements are attained. On March 25, 1999, Nestor Traffic Systems, Inc., a subsidiary of 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 for an additional 17.5% of its common stock for $1,750,000. The investor group includes three officers of the Company and the subsidiary, who in the aggregate contributed $600,000 of the initial cash invested on the same basis as third- party investors. The option expires on January 31, 2000. The proceeds will be used by the subsidiary to fund traffic-system product development and marketing efforts in 1999. In addition, to the extent that facility and administrative services of the Company are used by the subsidiary, reimbursement of allocated costs will be provided. The subsidiary has an exclusive license from the Company to apply the Company's proprietary technologies in the area of traffic-management systems. The license provides for royalties to the Company of 5% of related revenues, net of direct cost of third party goods sold, in 2000 and 10% in 2001 and beyond. NESTOR, INC. Part IV Item 14 Schedule II CONSOLIDATED FINANCIAL STATEMENT SCHEDULE VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Addition Balance at Charged to Deductions Balance at Beginning Charged to Other from End Description of Period Expense Accounts Reserve of Period Allowances deducted from accounts receivable: Year ended June 30, 1996 $ 57,976 $ 120,656 $ --- $(12,923) $165,709 Six months ended Dec. 31, 1996 $165,709 $ 38,888 $ --- $(59,362) $145,235 Year Ended Dec. 31, 1997 $145,235 $ 80,495 $ --- $(71,176) $154,554 Year ended Dec. 31, 1998 $154,554 $ 40,081 $ --- $(163,450) $ 30,300
ITEM 8. Financial Statement and Supplementary Data See annexed financial statements. ITEM 9. Changes in or Disagreement with Accounting and Financial disclosure Not Applicable. ITEM 10. Directors and Executive Officers of the Registrant. Incorporated by reference from the Company's definitive proxy or information statement to be filed with the Commission not later than 120 days following the end of the Company's fiscal year. ITEM 11. Executive Compensation. Incorporated by reference from the Company's definitive proxy or information statement to be filed with the Commission not later than 120 days following the end of the Company's fiscal year. ITEM 12. Security Ownership of Certain Beneficial Owners and Management. Incorporated by reference from the Company's definitive proxy or information statement to be filed with the Commission not later than 120 days following the end of the Company's fiscal year. ITEM 13. Certain Relationships and Related Transactions. Incorporated by reference from the Company's definitive proxy or information statement to be filed with the Commission not later than 120 days following the end of the Company's fiscal year. ITEM 14. Exhibits, Financial Statement, Schedules and Reports on Form 8-K. (a)The following documents are filed as part of this report: (1) The financial statements of the Company and accompanying notes, as set forth in the contents to the financial statements annexed hereto, are included in Part II, Item 8. Schedule II: Valuation and Qualifying Accounts and Reserves All other schedules are omitted because such information is not applicable (2) Exhibits numbered in accordance with Item 601 of Regulation S-K. (See Exhibit Index) Exhibits filed herewith: (None) (b) Reports on Form 8-K: On April 8, 1997, the Corporation filed with the Securities and Exchange Commission a current report on Form 8-K dated March 28, 1997 is hereby incorporated by reference. On April 10, 1997, the Corporation filed with the Securities and Exchange Commission a current report on Form 8-K dated March 31, 1997 is hereby incorporated by reference. On April 30, 1997, the Corporation filed with the Securities and Exchange Commission a current report on Form 8-K dated April 18, 1997 is hereby incorporated by reference. On May 7, 1997, the Corporation filed with the Securities and Exchange Commission a current report on Form 8-K dated May 6, 1997 is hereby incorporated by reference. INDEX OF EXHIBITS Exhibit Number Description of Exhibit 3.1 Certificate of Incorporation of the Company, filed as an Exhibit to the Company's Registration Statement on Form S18, Commission File No. 286182-B, is hereby incorporated herein by reference. 3.2 Amendment to the Certificate of Incorporation of the Company, dated December 5, 1985, filed as an Exhibit to the Company's Form 8 amending the Company's Form 10-K for the fiscal year ended June 30 1987 (the "1987 Form 8"), is hereby incorporated herein by reference. 3.3 Amendment to the Certificate of Incorporation of the Company, dated December 4, 1986, filed as an Exhibit to the 1987 Form 8, is hereby incorporated herein by reference. 3.4 Bylaws of the Company, as amended, filed as Exhibit to the 1987 Form 8, is hereby incorporated herein by reference. 4 Nestor, Inc. Incentive Stock Option Plan, as amended, filed as an Exhibit to the Company's Registration Statement on Form S-8, filed May 5, 1987, is hereby incorporated herein by reference. 10.1 Non-Exclusive Field-of-Use License Agreement dated June 21, 1988 between the Company and Morgan Stanley & Co. Incorporated, filed as an Exhibit to the Company's Form 10-K for the fiscal year ended June 30, 1988, is hereby incorporated herein by reference. 10.2 Cooperative Marketing Agreement dated May 26, 1988 between the Company and Arthur D. Little, Inc., filed as an Exhibit to the Company's Form 10-K for the fiscal year ended June 30, 1988, is hereby incorporated herein by reference. 10.3 Lease Rider dated February 6, 1985 between Richmond Square Technology Park Associates and the Company, filed as an Exhibit to the Company's Report on Form 10-K for the fiscal year ended June 30, 1986, is hereby incorporated herein by reference. 10.4 Employment Agreement dated August 4, 1986 between the Company and Michael G. Buffa, filed as Item 5 of the Company's Report on Form 8-K dated September 11, 1986, is hereby incorporated herein by reference. 10.5 Joint Venture Agreement between the Company and Oliver, Wyman & Co., dated December 4, 1986, filed as an Exhibit to the 1987 Form 10-K, is hereby incorporated herein by reference. 10.6 Employment Agreement dated as of July 1, 1989 between the Company and David Fox filed as an Exhibit to the 1989 Form 10-K is hereby incorporated by reference. 10.7 Employment Agreement dated as of September 15, 1988 between the Company and Douglas L. Reilly filed as an Exhibit to the 1989 Form 10- K is hereby incorporated by reference. 10.8 Memorandum dated January 1, 1989 regarding stock bonus plan for Douglas L. Reilly filed as an Exhibit to the 1989 Form 10-K is hereby incorporated by reference. 10.9 Amendment to Joint Venture Agreement dated May 8, 1990 between the Company and Oliver, Wyman & Co. filed as an Exhibit to the 1992 Annual Report on Form 10-K is hereby incorporated by reference. 10.10 License Agreement dated October 26, 1990 by and between the Company and Sligos, S. A. filed as an Exhibit to the Company's 1992 Annual Report on Form 10-K is hereby incorporated by reference. 10.11 Supplemental License Agreement dated September 9, 1991 by and between the Company and Sligos, S. A., filed as an Exhibit to the Company's 1992 Annual Report on Form 10-K, is hereby incorporated by reference. 10.12 NestorWriterT License and Development Agreement dated September 11, 1991 between the Company and Poqet Computer Corporation. 10.13 License Agreement for Product Development and Marketing dated October 30, 1990 between the Company and Lyonnaise des Eaux- Dumez. 10.14 Software Development Agreement dated October 30, 1990 between the Company and Lyonnaise des Eaux-Dumez. 10.15 License Agreement dated November 27, 1990 between the Company and Atari Corporation. 10.16 License Agreement for Product Development and Marketing dated March 18, 1991 between the Company and Dassault Electronique. 10.17 Agreement of Purchase and Sale dated August 16, 1991 between the Company and Diversified Research Partners filed as Item 5 of the Company's report on Form 8-K dated August 21, 1991 is hereby incorporated herein by reference. 10.18 License Agreement dated October 15, 1993, between the Company and Intel Corporation filed as an Exhibit to the Company's 1994 Annual Report on Form 10-K is hereby incorporated by reference. 10.19 Exclusive Marketing Agreement dated April 7, 1994, between the Company and Intel Corporation filed as an Exhibit to the Company's Current Report on Form 8-K dated April 7, 1994, is hereby incorporated by reference. 10.20 Securities Purchase Agreement dated August 1, 1994, between the Company and Wand/Nestor Investments L.P. ("Wand") filed as Item 5 of the Company's report on Form 8-K dated August 8, 1994, is hereby incorporated herein by reference. 10.21 Standby Financing and Purchase Agreement dated as of March 16, 1995 between the Company and Wand, filed as an Exhibit to the Company's Current Report on Form 8-K dated March 16, 1995, is hereby incorporated by reference. 10.22 First Amended and Restated Standby Financing and Purchase Agreement dated June 30, 1995 between the Company and Wand, filed as an Exhibit to the Company's Current Report on Form 8-K dated July 7, 1995, is hereby incorporated by reference. 10.23 Amendment Agreement dated December 20, 1994 between the Company and Sligos, S.A., filed as an Exhibit to the Company's Registration Statement on Form S-2, Commission File No. 33-93548, is hereby incorporated herein by reference. 10.24 Technology Development Subcontract dated December 20, 1994, between the Company and Alta Technology Corporation, filed as an Exhibit to the Company's Registration Statement on Form S-2, Commission File No. 33-93548, is hereby incorporated herein by reference. 10.25 Agreements between the Company and Europay International S.A. ("Europay") consisting of: (i) Fraud Study Agreement dated August 3, 1993, together with appendices and exhibits thereto; (ii) Confidentiality Agreement dated August 3, 1993; (iii) Nestor Fraud Detection System User License dated September 21, 1994; (iv) Source Code Addendum to Nestor Fraud Detection System User License, dated September 22, 1994; and (v) Memorandum of Understanding dated May 5, 1995, filed as an Exhibit to the Company's Registration Statement on Form S-2, Commission File No. 33-93548, is hereby incorporated herein by reference. 10.26 Lease of executive offices of the Company, together with the most recent rider thereto, filed as an Exhibit to the Company's Registration Statement on Form S-2, Commission File No. 33-93548, is hereby incorporated herein by reference. 10.27 Non-Exclusive License Agreement between the Company and International Business Machines Corporation, filed as an Exhibit to the Company's Current Report on Form 8-K dated January 30, 1996, is hereby incorporated by reference. 10.28 Securities Purchase and Exchange Agreement between the Company and Wand/Nestor Investments L.P., filed as an Exhibit to the Company's Current Report on Form 8-K dated January 30, 1996, is hereby incorporated by reference. 10.29 Securities Purchase Agreement between the Company and Wand/Nestor Investments L.P., filed as an Exhibit to the Company's Current Report on Form 8-K dated March 7, 1996, is hereby incorporated by reference. 10.30 Asset Purchase Agreement and License Agreement between the Company and National Computer Systems, Inc., filed as an Exhibit to the Company's Current Report on Form 8-K dated June 11, 1996, is hereby incorporated by reference. 10.31 PRISM Non-Exclusive License Agreement between the Company and Applied Communications, Inc., filed as an Exhibit to the Company's Current Report on Form 8-K dated September 19, 1996, is hereby incorporated by reference. Portions of the Exhibit omitted, pursuant to a grant of confidential treatment. 21 Nestor IS, Inc., a wholly-owned subsidiary of Nestor, Inc. incorporated January 1, 1997, doing business as Nestor Intelligent Sensors. 21.1 Nestor Interactive, Inc. a wholly-owned subsidiary of Nestor, Inc. incorporated January 1, 1997 4.1 Nestor, Inc. 1997 Incentive Stock Option Plan, as amended, filed as an Exhibit to the Company's Registration Statement on Form S-8, filed May 16, 1997, is hereby incorporated by reference. 10.32 License Agreement dated as of March 28, 1997, between Nestor, Inc. and Total System Services, Inc. filed as an Exhibit to the Company's Current report on Form 8-K dated April 8, 1997, is hereby incorporated by reference. Portions of the Exhibit omitted, pursuant to a grant of confidential treatment. 10.33 Asset Acquisition Purchase Agreement dated March 31, 1997 among Nestor Interactive, Inc., Cyberiad Software, Inc., Christopher L. Scofield and Jeffrey Pflum filed as an Exhibit to the Company's Current Report on Form 8-K dated April 10, 1997, is hereby incorporated by reference. 10.34 Nestor, Inc. 1997 Incentive Stock Option Plan, as amended, filed as an Exhibit to the Company's Current Report on Form 8-K dated May 6, 1997 is hereby incorporated by reference. 10.35 Amendment to the PRISM Non-Exclusive License Agreement dated as of April 18, 1997, between Nestor, Inc. and Applied Communications, Inc. filed as an Exhibit to the Company's Current Report on Form 8-K dated April 30, 1997 is hereby incorporated by reference. Portions of the Exhibit omitted pursuant to a grant of confidential treatment. 27 Financial data schedule for the year ended December 31, 1998. EX-27 2
5 12-MOS DEC-31-1998 DEC-31-1998 1,175,183 0 512,748 0 0 2,136,101 1,692,843 1,324,318 2,591,589 1,584,640 0 0 365,000 174,793 0 2,591,589 143,298 2,241,376 54,010 7,478,351 0 0 0 0 0 0 0 0 0 (5,263,153) (.36) (.36)
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