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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the period ended December 31, 2002
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file Number 0-12965
NESTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3163744
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(State of incorporation) (I.R.S. Employer
Identification No.)
400 Massasoit Avenue; Suite 200, East Providence, Rhode Island 02914
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(Address of principal executive offices) (Zip Code)
(401) 434-5522
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period than the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
Exhibit Index is on Page: 55
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1
The aggregate market value of the 24,034,535 shares of voting stock held by
non-affiliates of the registrant, based on the closing price of such stock on
February 28, 2003 was $2,163,108. The number of shares outstanding of the
Registrant's Common Stock at February 28, 2003 was 99,241,112.
2
PART I
ITEM 1. Business
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GENERAL
Nestor, Inc., and its wholly-owned subsidiary Nestor Traffic Systems, Inc.
(together the "Company"), licenses its patented intelligent software solutions
for decision and data-mining applications in real-time environments. Nestor
products employ proprietary neural network predictive models and other
algorithms to convert existing data and business experiences into meaningful
recommendations and actions. Nestor has designed and developed software products
that can bring additional value through proprietary software and information-
management knowledge. Nestor, through its subsidiary Nestor Traffic Systems,
Inc. ("NTS"), offers products in intelligent traffic-management systems ("ITS").
Nestor, through its resellers Applied Communications, Inc. ("ACI"), Retail
Decisions, Inc. ("ReD"), National Computer Systems, Inc. ("NCS"), licenses its
technologies and offers products in the following categories: Risk Management
Systems; Customer Relationship Management Systems ("CRM"); and Intelligent
Charter Recognition Systems ("ICR"). Nestor products and services include
application-software solutions, adaptive decision models, implementation,
training, consulting, and engineering support services. The Company is currently
devoting its resources to its ITS products.
Exclusive rights in the field of traffic-management solutions were granted to
the Company's wholly-owned subsidiary NTS on January 1, 1997; co-exclusive
rights in the field of Risk Management and non-exclusive rights in the field of
CRM are held by Applied Communications, Inc. (ACI) and Retail Decisions, Inc.
(ReD); and non-exclusive rights in the field of ICR are held by NCS.
NTS is an emerging leader in providing innovative, video-based monitoring
systems and services for traffic management and safety. NTS incorporates
patented pattern-recognition technologies into intelligent, real-time solutions
that promote traffic efficiency, intersection safety, and railway grade crossing
monitoring and safety. In the past, NTS has developed and marketed
CrossingGuard(R), Rail CrossingGuard(R), and TrafficVision(R). These products
are a combination of Nestor-developed software and modular hardware components
that provide monitoring for traffic-data collection, control of traffic flows,
enforcement and emergency response. These products are flexible and can be
configured to a wide range of road configurations, including open roads and
intersections.
RECENT DEVELOPMENTS
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard(R) installations. The Company terminated 19
full-time employees, affecting all departments, and offices were consolidated
into smaller facilities.
PRODUCTS
The Company's traffic enforcement products use high speed image processing and
target-tracking technology applied to real-time video scenes. The products use
software and video cameras to detect a range of traffic-related elements at
highways, intersections, and grade crossings.
CrossingGuard(R). CrossingGuard is an automated, video-based monitoring system
that predicts and records the occurrence of a red light violation. The software,
through a video camera, tracks vehicles approaching an intersection. Based on
the vehicle's speed, acceleration, and distance from the intersection, the
system predicts whether a red light violation will occur. If a violation is
expected to occur, the system can send a signal to the traffic controller to
request a brief extension of the red phase for cross traffic. This helps prevent
a collision between the violator and vehicles in the cross traffic accelerating
on a green signal. The system simultaneously records the violation sequence,
including a close-up of the vehicle and license plate, and transmits video
evidence electronically to the police department, which reviews the violation
and issues a citation. Citation mailing and other back-office services are
provided by the Company.
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The Company provides a complete turnkey solution, offering violation review,
citation preparation and processing, billing and collection, court scheduling,
evidence, and resolution. In addition, the Company provides direct, remote, and
online equipment monitoring and maintenance primarily through its field and
office personnel and through local contractors as necessary.
The CrossingGuard system consists of a video camera installed on top of a
roadside pole or mast arm. A personal computer is installed in the traffic
controller cabinet or in an enclosure by the wayside. High-speed communications
transmit video and data from the intersection to a designated facility for
processing. The facility is equipped with a CrossingGuard Server PC that
receives and stores violation data and supports authorized viewing of violation
video sequences.
CrossingGuard is built upon standard PC hardware and software components. This
design provides the reliability and performance benefits of PC hardware and the
ability to upgrade and add functionalities as needed. The Company purchases
components from third party vendors, built in accordance with Nestor's
specifications, and the systems are installed by local contractors.
CrossingGuard VIP. The CrossingGuard Video Intersection Profiling (VIP) program
is a proprietary tool that the Company has developed to help municipalities
pre-qualify intersections. Since intersection violation rates can range from an
average of a few per day to over fifty per hour, the system helps the
municipality develop an estimate of safety issues at a given intersection and
the long-term ticket volume by counting and profiling violations for all
directions at a particular intersection.
CrossingGuard Services. CrossingGuard Services is the complete package of
services and support that can be customized to a client's needs. It consists of
site planning and equipment installation, equipment maintenance, user training
and support, violation review, citation preparation and processing, account
management, toll free hotline support, public education, and expert testimony.
The economics of the CrossingGuard product are tied to the number of violations
processed by the systems and the number of operating systems in the field.
Generally, but not in all cases, the contracts require a monthly minimum fee
designed to allow NTS to recover the value of the system delivered, including a
finance factor and maintenance costs, over the term of the contract.
As of December 31, 2002, NTS had forty-two approaches installed and generating
citations, including two pilot program approaches, and an additional
ninety-seven approaches under contract and in various stages of delivery. As of
December 31, 2001, NTS had fourteen approaches installed and generating
citations, and an additional sixty-eight approaches contracted for and in
various stages of delivery. No assurances can be given that all approaches under
contract will ultimately be installed. The Company realizes from $25 to $97 per
citation issued or paid for system delivery, maintenance, software licensing,
and processing services, depending upon state statutes regarding driver versus
registered owner liability for a violation. Driver liability statutes require
the driver be identified in the photographic evidence and the citation be sent
to the identified driver. Registered owner statutes identify the vehicles owner,
through DMV records, as the responsible party for a violation. As only the
license plate is required for identification, program operating efficiencies are
much higher resulting in lower per citation fees to cities. Current trends in
the industry are towards compensating red-light program vendors on a fixed fee
basis instead of a variable fee basis tied to ticket volumes. Actual results
from deployment of CrossingGuard systems are expected to fluctuate substantially
depending upon intersection selection and configuration, driver response to
installed systems, and many other factors. Minimum monthly fee and fixed monthly
fees would reduce the risk of fluctuations in citation issuance rates.
During 2002, NTS realized $844,000 in CrossingGuard related revenues, which is
included in the Company's consolidated financial results in 2002. During 2001,
NTS realized $226,000 in CrossingGuard related revenues, of which $80,000 is
included in the Company's consolidated financial results in 2001.
Status of the CrossingGuard market. Ineffective red-light safety enforcement is
a costly and growing problem that until recently has been largely unaddressed by
technology solutions. There are an estimated 300,000 intersections with traffic
signals in the United States where approximately 106,000 collisions and over
1,000 deaths occurred as a result of red-light running as per Federal Highway
Administration 2000 statistics. First-generation Red-Light Camera Systems gained
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early acceptance as a means of automated traffic enforcement. While these
systems have validated the market opportunity, they generally continue to rely
on in-ground vehicle sensors ("loops") and still photography and have become
inferior solutions because of their (i) significant roadbed installation issues,
(ii) high maintenance requirements, (iii) inherently low level of performance,
and (iv) general lack of functionality.
Rail CrossingGuard. NTS is developing Rail CrossingGuard, a system to monitor
grade-crossing vehicle and train traffic, as well as signalization activity, to
provide grade-crossing-integrity measurement, real-time crossing alert
capabilities and crossing violation enforcement. This product has the potential
to greatly enhance rail-crossing safety by improving signal and crossing gate
performance, alerting personnel to dangerous crossing situations, and enforcing
train and vehicle safety regulations. Rail CrossingGuard may also be integrated
with train communications systems to provide a method of alerting trains to
dangerous rail crossing conditions.
On April 1, 2001, NTS completed its first Rail CrossingGuard installation in
DuPage County, Illinois and had completed design work necessary to commence
construction on the delivery of five Rail CrossingGuard units in Florida. In
addition, NTS has received a contract from the Federal Railroad Administration
("FRA") to develop a portable Rail CrossingGuard unit for non-permanent data
gathering capabilities. Also, NTS, working with GeoFocus, Inc., a Florida
company, won a contract to expand two of the Rail CrossingGuard units in Florida
to incorporate remote communication capabilities between Rail CrossingGuard
units and train operators. During 2002, NTS realized $426,000 in Rail
CrossingGuard related revenues, which is included in the Company's consolidated
financial results in 2002. During 2001, NTS realized $828,000 in Rail
CrossingGuard related revenues, of which $322,000 is included in the Company's
consolidated financial results in 2001. During 2002, the Company reduced its
marketing and sales efforts in this product line to focus its resources on the
CrossingGuard red-light enforcement market.
Status of the Rail CrossingGuard Market. About every 100 minutes, a train
collides with a vehicle or person at one of the United States' 261,000
highway-rail crossings. In an average year, more people die in highway-rail
crossing accidents than in commercial airline crashes. Grade crossing collisions
are usually severe, and chances of survival slim. In 2001 alone, there were
3,219 incidents at highway/rail grade crossings, resulting in 471 fatalities.
According to the FRA, most crossing collisions occur simply because motorists
chose to ignore warnings signs, signals or safety gates. Improperly functioning
gate arms and signals can increase motorist tendency to ignore and violate
crossing signals. State Departments of Transportation need the capability to
routinely monitor the integrity of grade-crossing signalization as well as to
receive real-time alerts of hazardous crossing conditions, such as a vehicle
that may be stopped or stuck at a crossing. Further, state regulatory agencies
currently have no means of effectively monitoring train activity at crossings to
ensure that train travel is compliant with stated regulations, nor do they have
a method of automatically enforcing train and vehicle compliance with crossing
signals. Such are the potential roles for Rail CrossingGuard.
TrafficVision. TrafficVision is a product that uses video cameras to monitor
traffic flow and to send traffic data to a central Traffic Operations Center.
Replacing short-life, high-maintenance, road-embedded copper-loop technologies
from the 1950's, TrafficVision is a non-intrusive sensor system for traffic
management. TrafficVision uses Nestor's proprietary high-speed image-processing
technology to analyze video content to sense and monitor traffic on highways,
roadways and intersections in real-time. TrafficVision recognizes and classifies
multiple vehicles continuously so that surveillance and traffic management are
based upon detailed, real-time information. TrafficVision is installed at 26
locations in Rhode Island and in the state's centralized Traffic Operations
Center in Providence. During 2002, NTS realized $187,000 in TrafficVision
related revenues, which is included in the Company's consolidated financial
results in 2002. During 2001, NTS realized $183,000 in TrafficVision related
revenues, of which $46,000 is included in the Company's consolidated financial
results in 2001. During 2002, the Company reduced its marketing and sales
efforts in this product line to focus its resources on the CrossingGuard
red-light enforcement market.
The following are the primary attributes of NTS products and services:
Accurate, real-time interpretation of traffic video images. NTS has applied
Nestor's high-speed pattern-recognition technologies in real-time processing and
video-image interpretation for traffic management, enforcement and safety. Prior
industry attempts to provide video-based detection of traffic have not proven
effective due to the difficulty of designing robust detection algorithms under a
variety of illumination, visibility and traffic conditions, as well as the need
to implement such algorithms on cost-effective computing platforms that provide
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real-time operation. Nestor's image-understanding technology is able to
interpret video images accurately and respond in a real-time environment at
affordable cost.
Vehicle trajectory analysis for real-time forecasting. As each frame in a video
sequence is interpreted, the individual objects in the scene are identified and
located. This information, passed from frame to frame, enables accurate tracing
of vehicles' trajectories. Unlike competitive vision systems, which note
changing images in a fixed and static area of the image (so-called virtual
loops), NTS's proprietary vehicle-centric technology can use the trajectories to
accurately predict vehicle positions. In the CrossingGuard application, when a
vehicle is about to run a red light, a signal can then be sent to the traffic
controller to extend the all-red phase of the traffic signal so that cross
traffic vehicles can be briefly delayed before they proceed into the
intersection. Thus, intersections equipped with CrossingGuard have the potential
to become smarter and safer.
Compatibility with industry standard platforms. NTS traffic monitoring solutions
are built upon dominant industry-standard platforms: namely, Microsoft Windows
operating systems, tools and communication components and general "WinTel"
hardware specifications. This facilitates integration into a customer's existing
computing environment, leverages PC economics to offer a compelling
price/performance advantage and lowers product engineering development costs.
Additionally, the traffic monitoring systems are designed to support the
emerging NTCIP communications standards being mandated in the traffic industry.
Further, roadside detector stations will be compatible with existing and new
traffic controller hardware, such as the CALTRANS 2070 controller standard.
Description of other products and services:
In 2001, Nestor ceased direct product development, sales and support in the
fields of fraud detection, financial risk management, and CRM. Through license
agreements entered into with ACI on February 1, 2001, and with ReD on May 18,
2001, co-exclusive development, sales and support rights were granted to these
resellers in fraud and risk management; and non-exclusive rights in the field of
CRM were granted to ReD. In addition, all expenses associated with development,
support and selling these products were transferred to these parties.
Nestor's PRISM(R) fraud detection solutions help financial institutions detect
and prevent fraudulent payments, manage merchant risks and identify illicit
account usage (money laundering). The fraud detection products are used by many
of the world's largest financial institutions and represented approximately 31%
and 87% of Nestor's 2002 and 2001 revenues, respectively. Effective July 1,
2002, the Company assigned its ACI royalty rights (Note 12) and no longer
receives product royalties.
Nestor's ICR applications increase productivity in document image-processing
applications. Royalties from the ICR business represented less than 1% of
Nestor's 2002 and 2001 revenues.
Nestor's technology is licensed to IBM on a non-exclusive basis for
incorporation into hardware products known as the ZISC family of computer chips.
Royalties from the IBM business represented less than 1% of Nestor's 2002 and
2001 revenues.
SALES, MARKETING AND METHODS OF DISTRIBUTION
The Company distributes and markets its intelligent traffic-management solution
("ITS") software and services in North America through a direct sales
organization. The Company distributed its other software solutions in North
America and throughout the world through third- party licensing and distribution
agreements.
The Company is in the process of transitioning itself from a technology driven
business to a sales and marketing enterprise. Currently, the Company markets its
products and services to municipalities, governmental traffic management
departments, or their integrators through its Providence and San Diego based
two-person direct sales force. Since the traffic products require technical
assistance during the sales and installation processes, the Company also
maintains an in-house staff of eight engineers. The Company obtains product
inquiries from product mailings, attendance at trade shows, trade press coverage
and its Internet site. Most CrossingGuard contracts are obtained through
competitive proposal processes in response to RFP's issued by municipalities.
6
The Company's Intelligent Character Recognition products are marketed by NCS.
The Company's PRISM and eCLIPSE products are licensed through two distributors,
Applied Communications, Inc. (ACI) and Retail Decision, primarily to financial
institutions. Effective with the sale of the future royalty revenues due from
the ACI license to Churchill Lane Associates, LLC (CLA) on September 30, 2002,
no future revenues related to the PRISM business are expected to be realized by
the Company.
During 2002, ACI accounted for 31% of the Company's revenues. During 2001, ACI
and ReD accounted for 52%, and 24% of the Company's revenues, respectively.
During 2000, ACI accounted for 65% of the Company's revenues. During 2002, Other
Income of $2,812,000 was recorded as a result of the sale of the ACI royalty
rights to CLA.
PATTERN-RECOGNITION TECHNOLOGY
The Company's technology deals with the problem of pattern recognition within
complex data. When presented with complex high-volume data, it can be valuable
to identify target patterns of information often hidden in that data, whether
patterns of fraudulent credit card use, customer buying behavior, handwritten
characters, objects in a video stream, vehicles in a traffic flow, or others.
Several methods currently exist to address the problem of processing information
in order to recognize a pattern in the information. Included among these are
"expert systems" of rules, statistical analysis, and neural networks. The
Company's products may combine all of these methods to optimize pattern
recognition capabilities.
Neural-networks simulate a virtual network of interconnected units, processing
data in parallel, and communicating with each other at high speeds. A trained
neural-network receives input and then outputs a response - either
"unrecognized", "recognized", or "not sure". Exceeding the capability of
if-then-else conditional rules, the power of the neural-networks is in their
ability to accurately recognize patterns in multi-dimensional non-linear input,
such as attempting to recognize characters from a scanned handwritten sample,
which is ill-defined, affected by "noise", or blatantly unusual (i.e. overly
large or small, or containing skewed characters). The Company, as the result of
extensive research, has created a proprietary neural-network technology referred
to as the Restricted Coulomb Energy Model(TM) (RCE), which has been granted five
patents.
The Company has also been granted a sixth patent for a multi-unit system
referred to as the Nestor Learning System(TM) ("NLS"), which is ideally suited
for many real-world pattern recognition applications. The NLS has a patented
hierarchical, multi-network system for better control and accuracy. The Company
believes that the rapid model development and operational flexibility afforded
by its technology provides a competitive advantage in the development of
intelligent-decision software solutions.
During 2002, the Company received two additional patents relative to the
CrossingGuard product line. The first patent recognizes the Company's invention
of providing for a collision avoidance feature in a video-based red light
enforcement system. The second patent recognizes the invention of a video-based
red light enforcement system integrating a client management system integrated
with a court scheduling system for ticket processing and issuance. In March, the
Company was informed that a third patent was being allowed relating to the
Company's method of predicting and recording a red light violation with a
video-based system.
RESEARCH AND DEVELOPMENT ACTIVITIES OF THE COMPANY
The Company continues to develop and improve its technologies and products and
to develop new technologies and products. The Company intends to pursue new and
enhanced technologies and products. The Company attempts to locate external
resources to assist in funding the costs of developing new technologies or
products, but may bear all of such costs internally.
The Company's research is almost entirely applied research intended to develop
solutions to specific pattern-recognition problems. This research has resulted
in various patents and patents pending relating to improvements to the Company's
basic technology (see "Patents"). The Company has additional patent applications
pending as of December 31, 2002, primarily in the area of traffic management,
enforcement and safety.
7
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 $1,604,000, $1,641,000 and $1,247,000 in the years ended
December 31, 2002, 2001 and 2000 respectively, in support of the various aspects
of Company-sponsored research and development. Prior to the September 12, 2001
merger, NTS expended $2,062,000 and $715,000 during 2001 and 2000, respectively,
in support of the various aspects of NTS-sponsored research and development,
which were not included in the December 31, 2002 consolidated financial
statements of the Company.
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 or the application of video
techniques in traffic management applications. The Company's RCE neural network
exhibits rapid learning and minimizes the internal connections needed for its
functioning. The Company believes that these capabilities make the Company's
technology uniquely suited to applications that require field trainability or
self-modification to adapt to new or changing patterns in the data. The
Company's patents also cover multiple-neural-network systems, which enable the
company to develop products that combine high accuracy with high processing
speeds.
Patents issued in the traffic management field include a patent for an
integrated traffic light violation citation generation and court date scheduling
system using a video-based traffic violation recording unit and a patent for a
video based traffic light collision avoidance system.
The Company owns eight United States patents and three foreign patents issued in
four countries and Europe. The foreign patents correspond to one or more of the
United States patents. The United States patents expire at various times from
2005 to 2019.
COMPETITION
The Company believes that CrossingGuard is more technologically advanced than
most competing systems for traffic safety enforcement. Its competition generally
consists of first generation "wet film" red light camera systems. These systems
rely on in-ground sensor loops and wet film, or on digital still cameras that
record only a few frames of evidence regarding a violation. For wet film
systems, there is the added burden of retrieving, replacing, developing, and
scanning the film.
CrossingGuard, on the other hand, is installed above the ground, on roadside
poles or mast arms. (This helps avoid some of the logistical problems associated
with installing in-ground sensors at an intersection.) In case of a dispute,
unlike other systems, the violation video sequence has the ability to provide an
instant replay of the event. Its digital video evidence consists of both front
and rear vehicle images and is viewed by the police who then issue (or give
authorization to issue) a citation. This ensures fairness so that violations may
not be issued out of context (e.g., if the violation occurred to make way for an
emergency vehicle, as part of a funeral procession, or to avoid a crash). In
addition, a high conviction rate resulting from the extensive evidence saves
court time and money, making the Company's video evidence preferred by city
councils, law enforcement officials, courts, and the general public.
NTS's largest competitor in the intersection market is Affiliated Computer
Services, Inc. (ACS), which has the greatest number of red-light camera systems
installed. Among others are EDS, Laser Craft, Mulvihill ICS, Peek Traffic,
Perceptics, Poltech, Redflex Traffic Systems, Traffipax, and Transcore. Although
these companies use buried loops, still or digital cameras and/or wet film
systems, some may pose a competitive threat due to their size, market share,
legacy customer relationships, additional products offered, and/or
citation-processing experience.
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NTS's TrafficVision and Rail products face competition primarily from
traffic-management-systems companies such as ISS, Econolite, Traficon, Iteris,
Peek Traffic, Odetics, Computer Recognition Systems, Siemens, Sumitomo, and
Rockwell International. Management believes that the platforms on which these
products operate do not provide the image processing capabilities possessed by
TrafficVision and Rail CrossingGuard. However, the Company is not currently
investing substantial finances in the marketing or sales of these product lines.
Most of the Company's competitors in the ITS market have significantly greater
financial, marketing and other resources than the Company. As a result, they may
be able to respond more quickly to new or emerging technologies or to devote
greater resources to the development, promotion and sale of their products than
the Company. Competitive pressures faced by the Company may materially adversely
affect its business, financial condition and results of operations.
CONTRACTS WITH GOVERNMENTAL ENTITIES
NTS's CrossingGuard agreements are generally service contracts with states or
municipalities that in most circumstances may be cancelled by the customer for
various reasons including non-appropriation of annual program funding. As these
contracts are generally self-funded from ticket fees collected from red-light
violators and some contracts contain termination fee provisions, NTS does not
expect this to be a significant risk in the future. NTS's Rail CrossingGuard and
TrafficVision contracts are generally fixed-fee deliverable contracts and
termination rights are generally limited to non-performance conditions. NTS
retains all patent and other proprietary rights from products developed and
delivered under government-supported contracts.
EMPLOYEES
As of December 31, 2002, the Company had thirty-five full-time employees,
including ten in software engineering and product development, nine in
processing and system support, seven in program management and field services,
two in sales and marketing and seven in management, finance and office support.
All of these employees are located in the United States. None of the Company's
employees are represented by a labor union. The Company has experienced no work
stoppages and believes its employee relationships are generally good.
The Company's success depends to a significant degree upon the continued
employment of the Company's key personnel. Accordingly, the loss of any key
personnel could have a materially adverse effect on the Company's business,
financial condition and results of operations. The Company believes its future
success will depend upon its ability to attract and retain industry-skilled
managerial, engineering, software development and sales personnel, for whom the
competition has been intense. In the past, the Company has experienced
difficulty in recruiting a sufficient number of qualified engineering and sales
people. In addition, competitors may attempt to recruit the Company's key
employees. There can be no assurance that the Company will be successful in
attracting, assimilating and retaining such qualified personnel, and the failure
to attract, assimilate and retain key personnel could have a materially adverse
effect on the Company's business, financial condition and results of operations.
LICENSING, JOINT VENTURE AND DEVELOPMENT AGREEMENTS
The Company entered into license agreements and research and development
contracts in order to obtain greater market penetration and additional funding
of the development of its technology in specific fields of use.
Applied Communications, Inc. (ACI) On February 1, 2001, the Company entered into
a new non-exclusive license agreement with Applied Communications, Inc., a
subsidiary of Transaction Systems Architects, Inc. Pursuant to the license
agreement, ACI has been granted the right to integrate and distribute all of the
Company's PRISM and fraud detection products throughout ACI's worldwide sales
and support network. ACI paid $1.1 million to the Company in four equal
installments over the four months following February 1, 2001, and was required
to make guaranteed minimum royalty payments during the first year in an amount
of approximately $500,000. The license requires the payment of a 15% royalty
starting on February 1, 2002, but no further guaranteed minimum royalty payments
will be required. This agreement replaces the license agreement signed with ACI
on April 18, 1997. Additionally, ACI hired twelve of the Company's engineering,
modeling, and customer support employees and assumes responsibility for product
9
enhancements, installation, modeling, and support for ACI licensees. The Company
sold the royalty rights to CLA on July 1, 2002. The Company does not expect to
receive future revenues from this license.
Retail Decisions, Inc. On May 18, 2001, Nestor entered into a license agreement
with Retail Decisions, Inc. ("ReD") in which Nestor granted to ReD: (i) an
exclusive (other than ACI), perpetual, fully-paid, worldwide license in the
field of use of fraud and money laundering detection and risk management in
certain defined industries; and (ii) a non-exclusive, perpetual, fully-paid,
worldwide license solely for use in the field of use of customer relationship
management in certain defined industries. Additionally, Nestor transferred to
ReD certain assets that were supportive of the technology licensed thereunder.
The assets transferred to ReD by Nestor include all of the right, title and
interest of Nestor in certain equipment, license agreements (excluding ACI) and
trademark rights. To support its newly acquired license, ReD hired 13 of
Nestor's employees. ReD paid $1,800,000 to Nestor under the license agreement,
and Nestor agreed, for certain marketing and transition services, to pay to ReD:
(i) $500,000 which was paid on July 2, 2001; (ii) $250,000 which was paid on
October 1, 2001; and (iii) $218,000 which was paid on December 31, 2001. The
Company recorded $832,000 as net license revenue in the second quarter in
connection with this agreement. No ongoing revenues are expected to be realized
from ReD.
National Computer Systems, Inc. (NCS) On June 11, 1996, the Company entered into
an exclusive Licensing Agreement and an Asset Purchase Agreement with NCS
transferring the development, production, and marketing rights of the Company's
Intelligent Character Recognition (ICR) products to NCS. In June 1998, NCS did
not meet its minimum royalty for the license year and forfeited exclusive
rights. NCS continues to market the ICR products on a non-exclusive basis.
ITEM 2. Properties.
----------
In 2001, NTS entered into a five-year lease for offices providing 9,600 square
feet for approximately $10,800 per month located at 400 Massasoit Avenue, East
Providence, Rhode Island 02914. NTS also maintains a local field office at 737
Pearl Street, La Jolla, CA 92037 on a twelve-month lease dated August 2002, and
pays approximately $1,500 per month. NTS also maintains a local field office
6528 Greenleaf Avenue, Suite 104, Whittier, CA 90601 on a month-to-month basis,
and pays approximately $410 per month. The Company believes these facilities are
adequate to meet its needs in the foreseeable future.
In April 2001, NTS entered into a forty-six month sublease for its California
operations at 10145 Pacific Heights Blvd., San Diego, CA 92121 providing for
approximately 5,700 square feet for $12,050 per month. As a result of the
Company's reorganization in early 2002, NTS could no longer use the amount of
space leased. Due to past due lease payments, the landlord terminated the lease
and notified NTS to leave the premises, which NTS did in early August 2002. The
Company is carrying a reorganization reserve related to projected costs of
settling this lease obligation, but has not reached agreement with the landlord
as to termination costs as of this date.
ITEM 3. Legal Proceedings.
-----------------
On July 12, 2002, Baldwin Line Construction of Maryland, Inc. filed a lawsuit
against Nestor Traffic Systems, Inc. in Fairfax County, Virginia, seeking
$117,105 plus interest related to invoices they claim are owed for construction
work in Falls Church, Virginia. The suit has been transferred to Arlington
County, Virginia. On November 15, 2002, NTS answered by filing its Grounds of
Defense. Additionally on November 15, 2002, NTS filed a counterclaim alleging
breach of contract and breach of warranty, seeking a $400,000 judgment to cover
NTS's losses in remedying the installation and lost revenues suffered from late
delivery of the system. The parties are conducting depositions and the case is
scheduled for trial in June 2003.
Management believes that all bona-fide invoices for services due to Baldwin have
been paid and intends to defend itself against these additional claims, but has
accrued $100,000 in the financial statements for costs related to this lawsuit.
Costs associated with the suit are being expensed as incurred. Although NTS
believes that it will prevail, there can be no assurance as to the outcome of
Baldwin's suit and NTS's counterclaim. Any conclusion of this litigation in a
manner adverse to NTS may have an adverse effect on its financial condition.
10
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, 2002.
11
PART II
ITEM 5. Market for Registrant's Common Stock and
Related Security Holder Matters.
----------------------------------------
The Company's common stock was first offered to the public in December 1983 and
is traded on the Nasdaq OTC Bulletin Board under the symbol "NEST."
Low Bid High Ask
------- --------
Year Ended December 31, 2002
- ----------------------------
1st Quarter $ .45 $ 1.03
2nd Quarter $ .18 $ .58
3rd Quarter $ .08 $ .28
4th Quarter $ .02 $ .10
Year Ended December 31, 2001
- ----------------------------
1st Quarter $ .44 $ .97
2nd Quarter $ .75 $ 1.80
3rd Quarter $ 1.00 $ 1.59
4th Quarter $ .77 $ 1.20
As at February 28, 2003, the number of holders of record of the issued and
outstanding common stock of the Company was 411, which includes brokers who hold
shares for approximately 1,550 beneficial holders.
The Company has not paid any cash dividends with respect to its Common Stock
since formation.
On February 7 and 13, 2003 and on March 6, 2003, the Corporation filed with the
Securities and Exchange Commission a Schedule 14C Preliminary Information
Statement, which is hereby incorporated by reference.
On March 14, 2003, the Corporation filed with the Securities and Exchange
Commission a Schedule 14C Definitive Information Statement, which is hereby
incorporated by reference.
On February 6, 2003, the Corporation filed with the Securities and Exchange
Commission a Schedule 13D for Silver Star Partners I, LLC, dated January 15,
2003, which is hereby incorporated by reference.
On January 17, 2003, the Corporation filed with the Securities and Exchange
Commission a current report on Form 8-K dated January 15, 2003, which is hereby
incorporated by reference.
On January 6, 2003, the Corporation filed with the Securities and Exchange
Commission a current report on Form 8-K dated January 2, 2003, which is hereby
incorporated by reference.
12
ITEM 6. Selected Financial Data.
-----------------------
The following data includes the accounts of Nestor, Inc. for all periods
presented and NTS for the period September 13, 2001 through December 31, 2001
and the years 2002 and 1998. (From January 1, 1999 through September 12, 2001,
the Company's investment in NTS was recorded on the equity method.) The data
reflects the activity of Interactive in 1998.
Years Ended December 31,
----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Revenue $ 2,121,574 $ 3,520,924 $ 3,652,422 $ 5,114,779 $ 2,241,376
Operating income (loss) $ (15,127,235) $ (1,297,145) $ (1,548,777) $ 742,451 $ (5,236,975)
Gain on royalty assignment $ 2,811,590 $ --- $ --- $ --- $ ---
Other expense $ (318,618) $ (186,809) $ (106,675) $ (97,386) $ (26,178)
Net loss $ (12,634,263) $ (1,565,054) $ (2,994,574) $ (836,824) $ (5,263,153)
Earnings per share
Weighted number of
outstanding shares -
basic and diluted 50,476,112 28,818,768 17,901,602 17,844,327 15,249,932
Loss per share $ (0.25) $ (0.05) $ (0.17) $ (0.05) $ (0.36)
SELECTED BALANCE SHEET DATA:
Total assets $ 9,200,964 $ 22,035,420 $ 4,922,703 $ 6,773,905 $ 3,250,089
Working capital (deficit) $ (1,572,209) $ 1,775,401 $ (199,775) $ 1,211,257 $ 535,806
Long-term
Capital lease obligations $ 2,849,126 $ 2,409,202 $ --- $ --- $ ---
Deferred income $ --- $ 421,399 $ 2,036,896 $ 1,965,532 $ 440,400
13
ITEM 7. Management's Discussion and Analysis
------------------------------------
PROSPECTIVE STATEMENTS
The Company experienced significant operating changes during the first
nine-months ended September 30, 2001 and subsequently, during the first six
months of 2002. During 2001, the Company changed its operating focus from
financial services products and services, primarily risk management software, to
intelligent traffic management products and services, primarily red-light
enforcement services and products. The Company entered into two separate
source-code licensing agreements for its PRISM product line appointing Applied
Communications, Inc. and Retail Decisions, Inc. as co-exclusive resellers in
industries of transaction processing. Additionally, essentially all engineering,
development, sales and marketing employees associated with the financial
solutions division were hired by these resellers. Royalty revenues from ACI
continued through June 2002 when the royalty was assigned to CLA, and no direct
license revenues, engineering and modeling revenues, or operating expenses will
be realized from this business. Subsequent to the completion of the merger with
Nestor Traffic Systems, Inc. on September 12, 2001, the Company's primary
operation is in the field of intelligent traffic management systems. The
financial statements and management's discussion and analysis of fiscal 2001
only include NTS results for the three and one-half month period from September
13, 2001 to December 31, 2001.
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities.
The following discussion contains prospective statements regarding the Company,
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 limited liquidity, the Company's ability to finance delivery of
current contracts, the Company's ability to successfully realize new contracts;
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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Nestor's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require the
Company to make estimates and assumptions (see Note 2 to the Consolidated
Financial Statements). The Company believes that of its significant accounting
policies (see Note 2 to the Consolidated Financial Statements), the following
may involve a higher degree of judgment and complexity.
Revenue Recognition
The Company's CrossingGuard product generates product licenses and service fee
revenue. Management estimates the percentage of citations that are expected to
be collectible and recognizes revenue accordingly. To the extent these estimates
are not accurate, the Company's operating results may be significantly and
negatively affected.
In arrangements, some of which include software, or where software services are
deemed essential, revenue is recognized using contract accounting. This
methodology involves a percentage-of-completion approach, based on
progress-to-completion measures on estimated total costs. If the Company does
14
not accurately estimate these total costs, or the projects are not properly
managed to planned periods and expectations, then future margins may be
significantly and negatively affected or losses on existing contracts may need
to be recognized.
Long Term Asset Impairment
In assessing the recoverability of the Company's long term assets, management
must make assumptions regarding estimated future cash flows and other factors to
determine the fair value. If these estimates change in the future, the Company
may be required to record impairment charges that were not previously recorded.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" (Note 5) and SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (Note 11).
LIQUIDITY AND CAPITAL RESOURCES
Cash Position and Working Capital
The accompanying financial statements have been prepared assuming that Nestor,
Inc. will continue as a going concern. As discussed in Note 1, the Company is
currently expending cash in excess of cash generated from operations, as
revenues are not yet sufficient to support future operations. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern without additional financing. Management's plans in regard to these
matters are discussed in Note 1. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
The Company had cash and short-term investments of approximately $309,000 at
December 31, 2002 as compared with approximately $3,239,000 at December 31,
2001. At December 31, 2002, the Company had a working capital deficit of
$1,572,000, as compared with working capital of $1,775,000 at December 31, 2001.
The decrease in working capital in 2002 reflects primarily working capital used
by operating activities.
The Company had a net worth of $3,865,000 at December 31, 2002, as compared with
a net worth of $16,392,000 at December 31, 2001. The decrease in net worth
resulted primarily from the consolidated net operating loss of $12,634,000 in
2002, which included an $8.5 million writedown of goodwill.
Additional capital will be required to enable the Company to carry out product
delivery efforts under current contracts, to underwrite the delivery costs of
future systems delivered under turnkey agreements with municipalities, for
continued development and upgrading of its products, for customer support,
marketing and sales efforts, and for other operating uses. If the Company does
not realize additional equity and/or debt capital and revenues sufficient to
maintain its operations at the current level, management of the Company would be
required to modify certain initiatives including the cessation of some or all of
its operating activities until additional funds become available through
investment or revenues.
In January 2003, the Company raised $2.3 million of additional capital through
the issuance of its common stock in the initial closing of a stock purchase
agreement. The second closing of this transaction is expected to occur in April
2003 and will increase the aggregate investment to a minimum of $3 million and
up to a maximum of $6 million in exchange for additional Nestor, Inc. common
shares. The Company is actively pursuing the raising of additional equity, debt
or lease financing. The possible success of these efforts, and the effect of any
new capital on the current structure of the Company, cannot be determined as of
the date of this filing.
Future Commitments
During 2002, the Company acquired additional property and leased equipment
(primarily computers and related equipment) at a cost of $48,000, and invested
$1,017,000 in capitalized systems. At December 31, 2002, Nestor recorded its
investments in computers and related equipment (net of depreciation) at
$487,000, and in capitalized systems (net of depreciation) at $1,937,000.
Management expects that NTS will make future commitments for the purchase of
15
additional computers and related computing equipment, for furniture and
fixtures, for delivery of capitalized systems, for consulting and for
promotional and marketing expenses.
On June 28, 2001, NTS executed a Master Lease Purchase Agreement with Electronic
Data Systems Corporation ("EDS"), whereby EDS would provide lease financing to
support installation of the NTS CrossingGuard(R) product to municipalities under
leasing terms. NTS received $3,183,180 in advances, drawn at $53,053 per
approach contracted to fund system equipment, design and installation costs.
Advances are collateralized by equipment delivered under leased CrossingGuard
systems and originally were being repaid interest (20%) only for the first 6
months and principal and interest over the next 60 months from each advance
date.
Payments were made as scheduled through February 2002, then the Company became
delinquent on payments and fell out of compliance with the lease agreement. On
January 10, 2003, the lease agreement was amended, pursuant to a letter
agreement between NTS and EDS dated July 18, 2002, to provide: (i) a moratorium
on NTS' interest obligations under the lease for the period from July 1, 2002
through June 30, 2003; (ii) a moratorium on all principal repayments through
June 30, 2003, at which time regular monthly payments will resume; (iii) all
lease payments in arrears as of June 30, 2002 will be accrued and payable as
follows, $150,000 on September 30, 2003, $100,000 on December 31, 2003, and
$37,590 on March 30, 2004; and (iv) effective July 1, 2002, the interest rate
factor upon which the lease payments are based was lowered to 12% per annum. EDS
will not extend additional financing under the Master Lease Purchase Agreement.
The Company does not generally grant payment terms to customers in excess of 90
days.
The Company's future contractual obligations and other commitments are as
follows:
Payment Due Date
Contractual ---------------------------------------------------------------------
Obligations Total < 1 Year 2-3 Years 4-5 Years Thereafter
----------- ----- -------- --------- --------- ----------
Capital lease obligations $ 4,252,000 $ 669,000 $ 1,714,000 $ 1,676,000 $ 193,000
including interest
Operating leases $ 356,000 $ 151,000 $ 205,000 $ --- $ ---
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
During the years ended December 31, 2002 and 2001, the Company reorganized by
(i) eliminating direct investment in its Risk Management products, transferring
all contracts to a pure royalty basis; (ii) reacquiring all unowned shares of
Nestor Traffic Systems, Inc. on September 12, 2001 and reporting the operating
results of this subsidiary after that date and (iii) through a further
operations reduction, focusing primarily on the CrossingGuard product.
Accordingly, comparisons of operating activity between fiscal 2001 and 2000 are
of operations that have changed materially. Looking forward, the consolidated
operating results reported during the fourth quarter of 2002 will more clearly
reflect the operating costs associated with the company in early 2003. Revenues
will come primarily from CrossingGuard products and services, and growth should
be tied to growth in the number of CrossingGuard approaches installed and
operational.
ANALYSIS OF THE THREE-MONTH PERIODS ENDED DECEMBER 31, 2002 AND 2001
In the quarter ended December 31, 2002, the Company realized a 41% decrease in
revenues compared to the prior year same quarter. Operating expenses decreased
65% in 2002 resulting in a loss before investment loss of $662,000 compared to
$2,365,000 in the prior year fourth quarter. As discussed below, there are no
ACI royalty revenues after the September 2002 royalty assignment as compared to
$227,000 in the prior year fourth quarter. Operating expense reductions include
16
payroll and facility rent costs after the June 2002 restructuring and reduced
consulting and cost of goods sold expenses associated with the Rail product line
development and deployment effort after spring 2002.
Revenues
- --------
The Company's revenues arose from royalties on product licenses and services as
discussed separately below. During the quarter ended December 31, 2002, revenues
decreased $233,000 to $334,000 from $567,000 in the prior calendar quarter.
Fiscal 2001 revenues included $227,000 in royalties from risk management
products and $340,000 from traffic management products and services. Fiscal 2002
revenues included $334,000 of traffic related revenues and no royalty revenues
were realized after the September ACI royalty assignment to CLA.
Operating Expenses
- ------------------
Total operating expenses amounted to $974,000 in the quarter ended December 31,
2002, a decrease of $1,843,000 as compared to total operating costs of
$2,817,000 in the prior year same quarter.
Cost of Goods Sold
Cost of goods sold (CGS) totaled $97,000 in the fourth quarter of 2002 as
compared to $600,000 in 2001. The 2002 CGS relates to CrossingGuard products
while 2001 CGS is primarily higher cost Rail product deployment.
Engineering Services
Costs related to engineering services totaled $596,000 in the fourth quarter of
2002, as compared with $362,000 in 2001. These costs include the salaries of
field and office personnel as well as operating expenses related to product
design, delivery, configuration, maintenance and service. This expense increased
in 2002, as there were more customers to support, requiring some staff
realignments from R&D to assist in the engineering efforts.
Research and Development
Research and development expenses totaled $31,000 in the quarter ended December
31, 2002 as compared with $1,030,000 in the previous year's quarter. R&D efforts
were significant in 2001 prior to significant rollouts of Rail and CrossingGuard
products, which occurred in 2002. The Company will continue its R&D activities
on a smaller scale and as deemed necessary.
Selling and Marketing
Selling and marketing costs decreased $233,000 to $89,000 in the quarter ended
December 31, 2002, from $322,000 in the previous year's quarter. The decrease
reflects a reduction in NTS expenses after the June 2002 reorganization.
General and Administrative
General and administrative expenses totaled $160,000 in the fourth quarter of
2002, as compared with $503,000 in the previous year's quarter. General and
administrative costs were lower in the current year due to a reversal of
$113,000 of Wand Partners, Inc. fees in connection with a Termination and
Release Agreement and reduced payroll expenses after the June 2002
restructuring.
Restructuring Costs
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities. During the quarter ended June 30, 2002, the Company recorded
restructuring costs of $743,000 primarily comprised of $332,000 in employee
17
severance agreements and estimated lease obligations associated with closing its
Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in
connection with the Providence office lease but no agreement has been finalized
regarding the amount due on the San Diego lease.
Capitalized Systems Costs Impairment
During the quarter ended June 30, 2002, the Company determined that potential
citation revenues from certain CrossingGuard installations in two cities would
not exceed the cost of the underlying carrying value of the capitalized systems.
These contracts were signed in the early stages of CrossingGuard development and
the site selection procedures and contract terms have since been improved. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company wrote off capitalized systems cost of $794,000
and recorded a corresponding impairment charge in operating expenses. Ongoing
revenues from these installations are expected to offset future costs of system
operations.
Goodwill Impairment Loss
As of January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 sets forth new financial accounting and
reporting standards that require goodwill to be separately disclosed from other
intangible assets in the statement of financial position, and no longer
amortized, but tested for impairment on an annual basis, or whenever indicators
of impairment are identified. The provisions of this accounting standard also
require the completion of a transitional impairment test within six months of
adoption, with any impairment identified accounted for as a cumulative effect of
a change in accounting principle. The Company completed the transitional
impairment test during the quarter ended June 30, 2002 and concluded that no
impairment existed on January 1, 2002, when the standard was adopted. Management
considers the Company's quoted stock price to be the best indicator of fair
value for purposes of performing these analyses.
Based on the decline of the Company's stock price during the second and third
quarters however, the fair value was recomputed using the quoted June 30, 2002
stock price of $.25 and September 30, 2002 stock price of $.09. Such
computations resulted in goodwill impairment charges of $3,000,000 and
$5,500,000 recorded as operating expenses during the respective quarters.
Although the Company's stock price declined to $.04 at December 31, 2002,
management considered the decline to be temporary in nature as the stock price
rebounded in 2003. If the Company's fair value declines below the September 30,
2002 measurement at a future quarterly measurement date and is deemed to be
other than temporary, further impairment changes will be required in the
respective future period. The Company will continue to monitor goodwill for
potential impairment.
Gain on Royalty Assignment
On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU")
with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the
Company's rights to royalty income under the license agreement between the
Company and ACI ("ACI License"). CLA is owned and controlled by Alan M. Wiener,
Alvin J. Siteman and Robert M. Carroll, directors and shareholders of the
Company. The MOU also provided a schedule for advances by CLA to provide interim
financing to the Company during the period prior to the closing. Upon closing on
September 30, 2002, CLA paid the Company $3.1 million in cash (less advances)
for the irrevocable assignment of its royalty rights under the ACI License from
July 1, 2002 and in perpetuity. No obligations or other rights of the Company
were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI
deferred income and $60,000 in related professional fees, the Company recorded a
$2,812,000 gain on this royalty assignment on September 30, 2002. The
elimination of ACI unbilled contract revenue and deferred income were recorded
as non-cash reductions.
Other Expense
- -------------
For 2002, net other expense was $22,000, as compared with net other expense of
$115,000 in the quarter-earlier period. In 2001, other expense was comprised
primarily of loss on asset disposals of $62,000 and both periods included
warrant amortization expense of $26,000.
18
Net Loss
- --------
During the fourth quarter in 2002, the Company experienced a loss of $662,000,
as compared with a loss of $2,365,000 in the previous year's quarter. For the
quarter ended December 31, 2002, loss per share available for common stock was
$0.01 per share, as compared with a loss per share of $0.05 in the corresponding
period of the prior fiscal quarter. The weighted average shares outstanding were
50,476,112 in both quarters.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2002 AND 2001
In the year ended December 31, 2002, the Company experienced a 40% decrease in
revenues compared to the prior calendar year. Operating expenses increased 258%
in 2002. The Company experienced a loss of $12,634,000 in 2002 compared to a
loss of $1,565,000 in the prior year.
Revenues
- --------
The Company's revenues arose from royalties and product licenses and services as
discussed separately below. During the year ended December 31, 2002, revenues
decreased $1,399,000 to $2,122,000 from $3,521,000 in the prior calendar year.
The company granted source-code distribution rights to two companies in 2001 for
up-front source-code license fees and, from ACI, ongoing royalties of equal to
15% of future revenues realized from the licensed software. Beginning in the
fourth quarter of 2001, the Company's revenues were generated primarily from
sales, support, and services provided regarding its intelligent traffic
management product line. Ongoing revenues from the risk management product line
continued under the ACI distributor agreement until July 2002 when it was
assigned to CLA.
Product Royalties
Product royalties totaled $664,000 in 2002, as compared with $2,997,000 in 2001.
The Company realized net ReD license revenues of $832,000 in the second quarter
of 2001 (See Note 20 of the financial statements), and $1,104,000 from the ACI
license in the first quarter of 2001 (See Note 19 of the financial statements).
The Company continued to receive royalties from ACI until July 1, 2002 when
these royalty rights were assigned to CLA.
Product Licenses and Services
Product license and services revenues from the traffic business totaled
$1,457,000 in 2002, as compared with $524,000 in 2001, which only included
post-merger revenue.
Operating Expenses
- ------------------
Total operating expenses amounted to $17,249,000 in the year ended December 31,
2002, an increase of $12,431,000 over total operating costs of $4,818,000 in the
prior year. The 2001 operating expenses reflect risk management operations that
were transferred to ACI and ReD in 2001 whereas the 2002 expenses reflect
current traffic management operations, which include $743,000 in restructuring
costs and $9,294,000 of impairment charges. Excluding restructuring and
impairment charges, operating expenses in 2002 were $7,212,000.
Costs of Goods Sold
Cost of goods sold totaled $1,476,000 in 2002 as compared to $692,000 in the
prior year, which included only post September 12, 2001 expenses. CGS includes
third party goods and services related to revenues recorded in the respective
periods and is high in proportion to revenues realized due to (i) rail projects
completed in the first quarter of 2002 that carried higher equipment and
construction costs than prior experience as NTS acted as prime contractor on
these construction related projects, and (ii) our back-office processing
agreement with EDS required a monthly minimum fee that was proportionately high
in relation to actual ticket volumes generated. As discussed in Note 17, in July
2002 a letter agreement was reached and finalized in January 2003 to eliminate
19
the monthly minimum fee, reducing the per-ticket processing fees charged
retroactive to January 1, 2002. In December 2002, NTS recorded a $102,000
reduction in CGS in connection with the modified terms. NTS will perform these
services internally as of March 31, 2003. Additionally, in the quarter ended
September 30, 2002, NTS reclassified customer-related telecommunications
expenses from various operating expenses to CGS, effective October 1, 2001.
Engineering Services
Costs related to engineering services totaled $2,070,000 in 2002, as compared
with $509,000 in 2001. The increase in these costs reflects the addition of NTS
engineering expenses effective on the merger completed September 12, 2001.
Research and Development
Research and development expenses totaled $1,604,000 in the year ended December
31, 2002 as compared with $1,623,000 in the prior year. These costs reflect the
net increased investment in the NTS products included in the consolidated
expenses after the merger completed on September 12, 2001, offset by the
transfer of PRISM research and development activity to ACI and ReD in early
2001.
Selling and Marketing
Selling and marketing costs decreased $171,000 to $608,000 in the year ended
December 31, 2002, from $779,000 in the prior year. The decrease in selling
costs in the year reflects, primarily, the transfer of sales and marketing
activity for the PRISM product to ACI and ReD during early 2001.
General and Administrative
General and administrative expenses totaled $1,453,000 in 2002, as compared with
$1,214,000 in the previous year. The increase is the net result of a full year
of combined Nestor and NTS expense in 2002, offset in part by the 2002 reversal
of $113,000 of Wand Partners, Inc. fees in connection with a Termination and
Release Agreement and reduced payroll expenses after the June 2002
restructuring.
Restructuring Costs
In June 2002, the Company underwent a significant restructuring involving
management changes and cost control to lower personnel and facilities expenses
as the Company refocused its efforts solely on its red-light video enforcement
contracts for CrossingGuard installations. The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities. During the quarter ended June 30, 2002, the Company recorded
restructuring costs of $743,000 primarily comprised of $332,000 in employee
severance agreements and estimated lease obligations associated with closing its
Providence, RI and San Diego, CA offices. A settlement was reached in 2002 in
connection with the Providence office lease but no agreement has been finalized
regarding the amount due on the San Diego lease.
Capitalized Systems Costs Impairment
During the quarter ended June 30, 2002, the Company determined that potential
citation revenues from certain CrossingGuard installations in two cities would
not exceed the cost of the underlying carrying value of the capitalized systems.
These contracts were signed in the early stages of CrossingGuard development and
the site selection procedures and contract terms have since been improved. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company wrote off capitalized systems cost of $794,000
and recorded a corresponding impairment charge in operating expenses. Ongoing
revenues from these installations are expected to offset future costs of system
operations.
20
Goodwill Impairment Loss
As of January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 sets forth new financial accounting and
reporting standards that require goodwill to be separately disclosed from other
intangible assets in the statement of financial position, and no longer
amortized, but tested for impairment on an annual basis, or whenever indicators
of impairment are identified. The provisions of this accounting standard also
require the completion of a transitional impairment test within six months of
adoption, with any impairment identified accounted for as a cumulative effect of
a change in accounting principle. The Company completed the transitional
impairment test during the quarter ended June 30, 2002 and concluded that no
impairment existed on January 1, 2002, when the standard was adopted. Management
considers the Company's quoted stock price to be the best indicator of fair
value for purposes of performing these analyses.
Based on the decline of the Company's stock price during the second and third
quarters however, the fair value was recomputed using the quoted June 30, 2002
stock price of $.25 and September 30, 2002 stock price of $.09. Such
computations resulted in goodwill impairment charges of $3,000,000 and
$5,500,000 recorded as operating expenses during the respective quarters.
Although the Company's stock price declined to $.04 at December 31, 2002,
management considered the decline to be temporary in nature as the stock price
rebounded in January 2003 after the announcement of a capital infusion. If the
Company's stock price declines below $.09 at a future quarterly measurement date
and is deemed to be other than temporary, further impairment changes will be
required in the respective future period. The Company will continue to monitor
goodwill for potential impairment.
Gain on Royalty Assignment
On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU")
with Churchill Lane Associates, LLC ("CLA"), assigning CLA certain of the
Company's rights to royalty income under the license agreement between the
Company and ACI ("ACI License"). CLA is owned and controlled by Alan M. Wiener,
Alvin J. Siteman and Robert M. Carroll, directors and shareholders of the
Company. The MOU also provided a schedule for advances by CLA to provide interim
financing to the Company during the period prior to the closing. Upon closing on
September 30, 2002, CLA paid the Company $3.1 million in cash (less advances)
for the irrevocable assignment of its royalty rights under the ACI License from
July 1, 2002 and in perpetuity. No obligations or other rights of the Company
were transferred or assigned to CLA.
After offsetting $860,000 of ACI unbilled contract revenue, $632,000 of ACI
deferred income and $60,000 in related professional fees, the Company recorded a
$2,812,000 gain on this royalty assignment on September 30, 2002. The
elimination of ACI unbilled contract revenue and deferred income were recorded
as non-cash reductions.
Other Expense
- -------------
For 2002, net other expense was $319,000; as compared with net other expense of
$187,000 in the year-earlier period. In 2002, other expense included interest
expense of $217,000 as compared to $65,000 in 2001, and both years included
$106,000 of amortization expense related to the assigned value of warrants
outstanding and being amortized over their remaining life. Interest expense was
considerably higher in 2002 as 2001 only included three and one-half months of
NTS interest expense.
Loss from Investment in Affiliate
- ---------------------------------
The pre-merger loss from investment in affiliate recorded in 2001 of $81,100
reflected Nestor's portion of NTS losses realized under the equity method of
accounting prior to the merger, and limited by Nestor's net investment in the
subsidiary as of December 31, 2000. Effective as of the merger, NTS operating
results are included in the consolidated financial statements.
Net Loss
- --------
During 2002, the Company experienced a loss of $12,634,000, as compared with a
loss of $1,565,000 in the prior year. For the year ended December 31, 2002, loss
per share was $0.25 per share, as compared with a loss per share of $0.05 in the
21
corresponding period of the prior fiscal year. For the year ended December 31,
2002, there was outstanding a weighted average of 50,476,112 shares, as compared
to 28,818,768 shares in the year-earlier period.
ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2001 AND 2000
In the year ended December 31, 2001, the Company realized a 4% decrease in
revenues compared to the prior calendar year. Expenses decreased 19% in 2001
resulting in a loss of $1,565,000 when compared to a loss of $2,995,000 in the
prior year.
Revenues
- --------
The Company's revenues arose from royalties and product licenses and services as
discussed separately below. During the year ended December 31, 2001, revenues
decreased $131,000 to $3,521,000 from $3,652,000 in the prior calendar year. The
Company granted source-code distribution rights to two companies in 2001 for
up-front source-code license fees and, from ACI, ongoing royalties of equal to
15% of future revenues realized from the licensed software. Beginning in the
fourth quarter of 2001, the Company's revenues were generated primarily from
sales, support, and services provided regarding its intelligent traffic
management product line.
Product Royalties
Product royalty revenues totaled $2,997,000 in 2001, as compared with $2,537,000
in 2000. The Company realized net ReD license revenues of $832,000 in the second
quarter of 2001 (See Note 20 of the financial statements), and $1,104,000 from
the ACI license in the first quarter of 2001 (See Note 19 of the financial
statements).
Product Licenses and Services
Product licenses and services revenues totaled $524,000 in 2001, as compared
with $1,115,000 in 2000. The decrease is primarily the result of the transfer of
engineering and modeling services related to PRISM licenses to either ACI in
February 2001 or ReD in May 2001. Fourth quarter product licenses and services
revenues in 2001 of $340,000 relate primarily to traffic system revenues
generated after the merger was completed on September 12, 2001.
Operating Expenses
- ------------------
Total operating expenses were $4,818,000 in the year ended December 31, 2001, a
decrease of $383,000 over total operating costs of $5,201,000 in the prior year.
Cost of Goods Sold
Cost of goods sold was $692,000 in 2001 as compared to none in 2000. As NTS was
not consolidated until September 13, 2001, there is no related CGS in 2000.
Engineering Services
Costs related to engineering services totaled $509,000 in 2001, as compared with
$967,000 in 2000. The decrease reflects the transfer of PRISM engineering
expenses to ACI and ReD in early 2001, offset in part by the addition of NTS
engineering expenses effective on the merger completed September 12, 2001.
Research and Development
Research and development expenses totaled $1,623,000 in the year ended December
31, 2001 as compared with $1,247,000 in the prior year. The increase in such
costs reflects the net of increased investment in the NTS products included in
the consolidated expenses after the merger completed on September 12, 2001.
22
Selling and Marketing
Selling and marketing costs decreased $715,000 to $779,000 in the year ended
December 31, 2001, from $1,494,000 in the prior year. The decrease in selling
costs in the year reflects, primarily, the transfer of sales and marketing
activity for the PRISM product to ACI and ReD during early 2001.
General and Administrative
General and administrative expenses totaled $1,214,000 in 2001, as compared with
$1,493,000 in the previous year. The decrease reflects a decrease in legal
expenses related to the Nestor versus HNC Software lawsuit settled in January
2001 and the contribution to overhead and facility cost by ReD and ACI under
sublicense agreements during 2001, offset in part by the inclusion of NTS
expenses after the merger on September 12, 2001.
Other Expense
- -------------
For 2001, net other expense was $187,000, as compared with net other expense of
$107,000 in the year-earlier period. In 2001, other expense included loss on
asset disposals of $62,000, and both years included $106,000 of amortization
expense related to the assigned value of warrants outstanding and being
amortized over their remaining life.
Loss from Investment in Affiliate
- ---------------------------------
During 2000, the Company's affiliate NTS sold additional common stock interests
reducing the Company's equity interest in the affiliate to 34.6%. The Company's
interests in NTS were accounted for under the equity method of accounting in
2000 and 1999. As a result of the Company's equity interest in NTS, the Company
reported a loss from investment in affiliate of $1,339,000 in 2000, representing
34.6% of NTS's actual net loss in 2000 of $3,513,000. The pre-merger loss from
investment in affiliate recorded in 2001 of $81,100 reflected Nestor's portion
of NTS losses realized under the equity method of accounting prior to the
merger, and limited by Nestor's net investment in the subsidiary as of December
31, 2000.
Net Loss
- --------
During 2001, the Company experienced a loss of $1,565,000, as compared with a
loss of $2,995,000 in the prior year. For the year ended December 31, 2001, loss
per share was $0.05 per share, as compared with a loss per share of $0.17 in the
corresponding period of the prior fiscal year. For the year ended December 31,
2001, there was outstanding a weighted average of 28,818,768 shares, as compared
to 17,901,602 shares in the year-earlier period.
ITEM 7(a) Quantitative and Qualitative Disclosure about Market Risk.
---------------------------------------------------------
The Company has long term lease obligations, however the interest rate is fixed.
Therefore, management assesses their exposure to these risks as immaterial.
ITEM 8. Financial Statements and Supplementary Data
-------------------------------------------
See annexed financial statements.
23
ITEM 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure
---------------------------------------------
On January 6, 2003, the Company filed with the Securities and Exchange
Commission a current report on Form 8-K dated January 2, 2003 to disclose the
change in Certifying Accountants. Ernst & Young LLP audited the Company's
financial statements for the year ended December 31, 2001. Their opinion on the
2001 financial statements did not contain an adverse opinion or disclaimer of
opinion nor was it qualified or modified as to uncertainty, audit scope or
accounting principles except that it included a paragraph indicating that there
was substantial doubt about the Company's ability to continue as a going
concern. There have been no disagreements with Ernst & Young LLP relating to any
matters of accounting principles or practices, financial statements, disclosures
or auditing scope or procedures for the year ended December 31, 2001, which
disagreements, if not resolved to the satisfaction of Ernst & Young LLP, would
have caused it to make a reference to the subject matter of the disagreement(s),
in connection with its report. During the year ended December 31, 2001 and the
subsequent period preceding Ernst & Young's resignation, no event occurred that
is required to be disclosed pursuant to paragraph (a)(1)(v) of Item 304 of
Regulation S-K.
On January 2, 2003, the Company's Audit Committee of the Board of Directors
engaged the independent accounting firm, Carlin, Charron & Rosen LLP, 50
Exchange Terrace, Providence, Rhode Island 02903, a member of the Securities and
Exchange Commission practice section of the AICPA, to audit the fiscal year
ended December 31, 2002. The Company did not during the fiscal year ended
December 31, 2002 or any subsequent period consult Carlin, Charron & Rosen LLP
regarding the application of accounting principles to a specific transaction or
with respect to the type of audit opinion that might be rendered on the
Company's financial statements or any matter to be disclosed pursuant to
paragraph (a)(2) of Item 304 of Regulations S-K.
24
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused the report to be signed on its
behalf by the undersigned, thereunto duly authorized.
NESTOR, INC.
(Registrant)
/s/ William B. Danzell
-----------------------------------------------------
William B. Danzell, Chief Executive Officer
/s/ Nigel P. Hebborn
-----------------------------------------------------
Nigel P. Hebborn, Chief Financial Officer
Date: March 28, 2003
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/ Alan M. Wiener
- -------------------------
Alan M. Wiener Chairman of the Board March 28, 2003
/s/ William B. Danzell
- ------------------------- Chief Executive Officer
William B. Danzell and Director March 28, 2003
/s/ J. Steve Emerson
- -------------------------
J. Steven Emerson Director March 28, 2003
/s/ Nigel P. Hebborn
- ------------------------- President, Chief Financial Officer
Nigel P. Hebborn and Director March 28, 2003
/s/ Robert M. Krasne
- -------------------------
Robert M. Krasne Director March 28, 2003
/s/ Stephen H. Marbut
- -------------------------
Stephen H. Marbut Director March 28, 2003
/s/ David A. Polak
- -------------------------
David A. Polak Director March 28, 2003
/s/ Douglas L. Reilly
- -------------------------
Douglas L. Reilly Director March 28, 2003
/s/ Bruce W. Schnitzer
- -------------------------
Bruce W. Schnitzer Director March 28, 2003
25
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, William B. Danzell, certify that:
1. I have reviewed this annual report on Form 10-K of Nestor, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 28, 2003
/s/ William B. Danzell
- ------------------------------------------
William B. Danzell Chief Executive Officer
26
CERTIFICATION
I, Nigel P. Hebborn, certify that:
1. I have reviewed this annual report on Form 10-K of Nestor, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 28, 2003
/s/ Nigel P. Hebborn
- ------------------------
Nigel P. Hebborn
Chief Financial Officer
27
PART II
ITEM 8.
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
FORM 10-K
---------
December 31, 2002
-----------------
28
NESTOR, INC.
CONTENTS
----------------
Page No.
-------
INDEPENDENT AUDITORS' REPORTS 30
CONSOLIDATED BALANCE SHEETS -
December 31, 2002 and 2001 32
CONSOLIDATED STATEMENTS OF OPERATIONS -
For the Years Ended December 31, 2002, 2001 and 2000 33
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -
For the Years Ended December 31, 2002, 2001 and 2000 34
CONSOLIDATED STATEMENTS OF CASH FLOWS -
For the Years Ended December 31, 2002, 2001 and 2000 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 36
29
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
of Nestor, Inc.
East Providence, Rhode Island
We have audited the accompanying consolidated balance sheet of Nestor, Inc. as
of December 31, 2002, and the related consolidated statements of operations,
stockholders' equity and cash flows for the year ended December 31, 2002. Our
audit also included the financial statement schedule for the year ended December
31, 2002 listed in the index at Item 15(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
audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2002 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Nestor, Inc. at
December 31, 2002 and the consolidated results of its operations and its cash
flows for the year ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule when considered in relation to
the basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
The accompanying financial statements have been prepared assuming that Nestor,
Inc. will continue as a going concern. As discussed in Note 1, the Company has
incurred significant losses to date and has an accumulated deficit at December
31, 2002. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are discussed in Note 1. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/Carlin, Charron & Rosen LLP
Providence, Rhode Island
February 26, 2003
30
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
of Nestor, Inc.
We have audited the accompanying consolidated balance sheet of Nestor, Inc. as
of December 31, 2001, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years ended December 31, 2001 and
2000. Our audit also included the financial statement schedule listed for the
years ended December 31, 2001 and 2000 in the index at Item 15(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 audit.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Nestor, Inc. at
December 31, 2001, and the consolidated results of its operations and its cash
flows for each of the two years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that Nestor,
Inc. will continue as a going concern. As discussed in Note 1, the Company is
currently expending cash in excess of cash generated from operations, as
revenues are not yet sufficient to support operations and the Company has
incurred significant losses. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are discussed in Note 1. The financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
/s/Ernst & Young LLP
Providence, Rhode Island
February 26, 2002
31
NESTOR, INC.
Consolidated Balance Sheets
---------------------------
DECEMBER 31,
ASSETS 2002 2001
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 308,894 $ 2,294,987
Restricted cash --- 943,926
Accounts receivable 141,263 158,206
Unbilled contract revenue 122,684 595,023
Inventory 281,108 375,098
Other current assets 60,963 220,483
------------- -------------
Total current assets 914,912 4,587,723
NONCURRENT ASSETS:
Long term unbilled contract revenue --- 421,399
Capitalized system costs, net of accumulated depreciation 1,936,783 2,079,938
Property and equipment, net of accumulated depreciation 486,740 652,644
Goodwill 5,580,684 14,080,684
Patent development costs, net of accumulated amortization 153,275 135,242
Other long term assets 128,570 77,790
------------- -------------
TOTAL ASSETS $ 9,200,964 $ 22,035,420
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 616,878 $ 601,361
Accrued employee compensation 354,269 478,444
Accrued liabilities 795,749 944,298
Deferred income --- 481,892
Leases payable 354,286 306,327
Restructuring reserve 365,939 ---
------------- -------------
Total current liabilities 2,487,121 2,812,322
NONCURRENT LIABILITIES:
Long term deferred income --- 421,399
Long term leases payable 2,849,126 2,409,202
------------- -------------
Total liabilities 5,336,247 5,642,923
------------- -------------
Commitments and contingencies --- ---
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, authorized 10,000,000 shares;
issued and outstanding: Series B - 235,000 shares at
December 31, 2002 and 2001 235,000 235,000
Common stock, $.01 par value, authorized 100,000,000 shares;
issued and outstanding: 50,241,112 shares at December 31, 2002
and 2001 502,411 502,411
Warrants 1,072,825 2,612,368
Additional paid-in capital 44,775,681 43,129,655
Accumulated deficit (42,721,200) (30,086,937)
------------- -------------
Total stockholders' equity 3,864,717 16,392,497
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,200,964 $ 22,035,420
============= =============
SEE INDEPENDENT AUDITORS' REPORTS AND NOTES TO THE FINANCIAL STATEMENTS.
32
NESTOR, INC.
Consolidated Statements of Operations
-------------------------------------
YEARS ENDED DECEMBER 31,
2002 2001 2000
----------------------------------------------------
Revenue:
Product royalties $ 664,401 $ 2,996,550 $ 2,537,511
Product licenses and services 1,457,173 524,374 1,114,911
------------- ------------- -------------
Total revenue 2,121,574 3,520,924 3,652,422
------------- ------------- -------------
Operating expenses:
Cost of goods sold 1,475,945 692,418 ---
Engineering services 2,070,476 508,955 966,681
Research and development 1,604,159 1,623,182 1,247,205
Selling and marketing 607,901 779,389 1,493,968
General and administrative 1,453,342 1,214,125 1,493,345
Restructuring costs 742,705 --- ---
Capitalized system costs impairment 794,281 --- ---
Goodwill impairment loss 8,500,000 --- ---
------------- ------------- -------------
Total operating expenses 17,248,809 4,818,069 5,201,199
------------- ------------- -------------
Loss from operations (15,127,235) (1,297,145) (1,548,777)
Gain on royalty assignment 2,811,590 --- ---
Other expense - net (318,618) (186,809) (106,675)
-------------- -------------- --------------
Loss before investment loss (12,634,263) (1,483,954) (1,655,452)
Loss from investment in affiliate --- (81,100) (1,339,122)
------------- -------------- --------------
Net loss $ (12,634,263) $ (1,565,054) $ (2,994,574)
============== ============== ==============
Loss Per Share:
Loss per share, basic and diluted $ (0.25) $ (0.05) $ (0.17)
============== ============== ==============
Shares used in computing loss per share:
Basic and diluted 50,476,112 28,818,768 17,901,602
============== ============== ==============
SEE INDEPENDENT AUDITORS' REPORTS AND NOTES TO THE FINANCIAL STATEMENTS.
33
Nestor, Inc.
Consolidated Statement of Stockholders' Equity
For the Years Ended December 31, 2002, 2001 and 2000
----------------------------------------------------
Additional
Paid-in Accumulated
Common Stock Preferred Stock Capital Deficit Warrants Total
--------------------- ---------------------- ---------- ----------- -------- -----
Shares Amount Shares Amount
------ ------ ------ ------
Balance at
December 31, 1999 17,499,327 $174,993 345,000 $ 345,000 $26,574,123 $(25,527,309) $ 736,951 $ 2,303,758
Issuance of
Common Stock 79,122 791 --- --- 84,846 --- --- 85,637
Conversion of
Preferred Stock
to Common Stock 110,000 1,100 (110,000) (110,000) 108,900 --- --- ---
Issuance of equity
by subsidiary --- --- --- --- 666,260 --- --- 666,260
Accretion value
of warrants --- --- --- --- --- --- 106,483 106,483
Loss for the
year ended
December 31, 2000 --- --- --- --- --- (2,994,574) --- (2,994,574)
---------- -------- ------- --------- ----------- ------------ ----------- ------------
Balance at
December 31, 2000 17,688,449 $176,884 235,000 $ 235,000 $27,434,129 $(28,521,883) $ 843,434 $ 167,564
Issuance of
Common Stock 32,338,558 323,386 --- --- 17,199,473 --- --- 17,522,859
Accretion value
of warrants --- --- --- --- --- --- 106,484 106,484
Variable warrants --- --- --- --- (1,662,450) --- 1,662,450 ---
Options exercised 214,105 2,141 --- --- 158,503 --- --- 160,644
Loss for the
year ended
December 31, 2001 --- --- --- --- --- (1,565,054) --- (1,565,054)
---------- -------- ------- --------- ----------- ------------ ----------- ------------
Balance at
December 31, 2001 50,241,112 $502,411 235,000 $ 235,000 $43,129,655 $(30,086,937) $ 2,612,368 $ 16,392,497
Accretion value
of warrants
--- --- --- --- --- --- 106,483 106,483
Variable warrants
--- ---