Back to GetFilings.com
15
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 fiscal year ended June 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file Number 0-12965
NESTOR, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3163744
(State of incorporation) (I.R.S. Employer
Identification No.)
One Richmond Square, Providence, Rhode Island 02906
(Address of principal executive offices) (Zip Code)
(401) 331-9640
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period than the Registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of Registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Exhibit Index is on Page _________
The aggregate market value of the voting stock held by non-
affiliates of the registrant, based on the average bid and asked
prices of such stock on September 17, 1996 was $11,189,677. The
number of shares outstanding of the Registrant's Common Stock at
September 17, 1996 was 8,548,141.
DOCUMENTS INCORPORATED BY REFERENCE.
Information to be included in registrant's definitive proxy or
information statement to be filed with the Commission not later
than 120 days following the end of registrant's fiscal year is
incorporated by reference in Part III of the Form 10-K.
ITEM 1. Business
Prospective Statements
The following discussion contains prospective statements
regarding Nestor, Inc. ("Nestor" or "the Company"), its business,
outlook and results of operations that are subject to certain
risks and uncertainties and to events that could cause the
Company's actual business, prospects and results of operations to
differ materially from those that may be anticipated by, or
inferred from, such prospective statements. Factors that may
affect the Company's prospects include, without limitation:, the
Company's ability to successfully develop new contracts for
technology development; the impact of competition on the
Company's revenues or market share; delays in the Company's
introduction of new products; and failure by the Company to keep
pace with emerging technologies.
Readers are cautioned not to place undue reliance on these
prospective statements, which speak only as of the date of this
report. The Company undertakes no obligation to revise any
forward-looking statements in order to reflect events or
circumstances that may subsequently arise. Readers are urged to
carefully review and consider the various disclosures made by the
Company in this report and in the Company's reports filed with
the Securities and Exchange Commission.
General
Nestor, Inc. designs, develops, markets, and supports intelligent
software solutions for mission-critical decision applications in
real-time environments. Nestor employs proprietary neural
network predictive models to convert existing data and business
experiences into meaningful recommendations and actions. The
Company has leveraged its neural-network software architecture
across a wide range of markets, including financial-institution
credit/debit card fraud and real-time traffic-control systems.
In addition, the Company believes that its technology and
software architecture are well suited for intelligent decision
applications addressing a variety of other markets, including
health care payments, long distance and mobile phone fraud,
database marketing, and intranet/internet information discovery
applications.
For its fiscal year ended June 30, 1996, the Company realized a
71% increase in operating revenues to $5,461,580 and experienced
a profit of $12,690 after taxes. Year ended June 30, 1995
revenues were $3,195,563 and a net loss of $3,457,422 was
reported. Revenues for fiscal 1996 include an initial license
fee in the amount of $1,400,000 received by the Company in
connection with the granting of an exclusive license to National
Computer Systems, Inc. ("NCS") of the Company's "NestorReader"
family of character-recognition products, and a non-recurring
gain (net of expenses) of $213,000 on the sale of assets used in
that business. These products accounted for $1,425,600 or 35% of
the Company's revenues in fiscal 1996, excluding the two
aforementioned items, and $1,713,897 or 54% of the Company's
revenues in fiscal 1995. (See Item II, "Management's Discussion
and Analysis".)
Background
The Company was incorporated under the laws of the State of
Delaware on March 21, 1983, in order to exploit, develop and
succeed to certain patent rights and know-how relating to the
Nestor Learning SystemT ("NLS"), which the Company acquired in
1983 from its predecessor Nestor Associates, a limited
partnership. NLS is an adaptive or self-organizing software
system, commonly referred to as a neural network, that is capable
of extracting the salient features of input patterns without
being told what features to look for and of subsequently
recognizing similar patterns identified by such features. Thus,
NLS can be said to learn from its experience.
Nestor Products
Nestor offers complete application-software solutions that
include adaptive decision models, implementation, education,
training, consulting and engineering support services. Current
Nestor software products detect credit/debit card fraud (PRISMT),
provide remote traffic management of freeways and intersections
(TrafficVisionT), and provide much greater efficiencies in
document processing and fax distribution environments (OmniTools
& N'Route, which were exclusively licensed to NCS in June 1996).
Nestor's software solutions are designed for client-server
implementation and flexible integration with customers' existing
computing infrastructures. Installation time periods for the
Company's software solutions depend upon the particular product
involved, and can take as little as three days or as long as six
months. The Company believes that PRISM customer payback periods
for license, installation, and first year user fees are typically
less than one year.
The Company designs and develops specialized software products
utilizing its proprietary software and information-management
knowledge, and, to a lesser degree, designs hardware components
that will enhance the performance of its software products. The
Company's products comprise the following categories: Fraud
Detection and Risk Assessment Systems - are designed to
effectively detect and control fraudulent transactions for
financial institutions that issue credit, debit, or other
financial use cards. The Company is evaluating the expansion of
these product technologies into additional applications such as
health-care payments, long-distance telephone fraud, mobile-phone
service theft, and database marketing. Traffic Management
Systems - are a combination of internally developed software and
internally and externally developed hardware components that
perform as a traffic management system for open road and
intersection applications. The products enable dual use of video
networks to support both traffic/roadway surveillance and traffic
data collection. Intelligent Character Recognition Systems -
include packages of software applications such as OmniTools,
NestorReader, and N'Route which increase productivity in document
processing and fax distribution environments.
Fraud Detection and Risk-Assessment Systems
Custom software packages developed by the Company are the
Proactive Risk Management (PRISMT) and the Nestor Fraud Detection
(FDST) systems, which have been licensed to six financial-
services clients as of June 30, 1996. These systems can detect
bank-card or credit-card fraud, and can be readily updated by
clients to adapt to changing patterns of fraudulent
transactions. By monitoring each cardholder's historical and
current transactions, PRISM is capable of detecting unusual
patterns of card use and of rapidly detecting a significant
proportion of fraudulent transactions with an extremely low error
rate. Customers have reported a reduction of more than 50% in
their credit-card fraud loss experience within 30 days of
installation.
In March 1993, the Company completed the installation of its FDS
product at Mellon Bank. The success of the FDS installation at
Mellon has been instrumental in obtaining additional orders for
FDS and PRISM. Like many other credit-card issuers, Mellon Bank
had been using a rule-based system for fraud detection. Mellon
has reported to the Company that FDS is finding 20 times as many
instances of fraud as their rule-based system, while requiring
reviews of only one-third as many accounts.
In December 1994, the Company installed a merchant-fraud
detection system at Europay International S.A., a Master Card
affiliated association of 700 banks that settle international
bank-card transactions involving currency exchange. Experience
with United Kingdom and Belgium banks indicates a counterfeit
detection rate of up to 50%.
In February 1995, the Company announced PRISMT. PRISM enhances
the fraud-detection capabilities of FDS to include workflow
management and other PC-based productivity tools that are
designed to enable the fraud manager and fraud-control team to
efficiently identify and track frauds detected by the system.
The initial PRISM system was an FDS installed at G.E. Capital
Consumer Financial Services, which was upgraded to incorporate
PRISM in 1995.
PRISM is currently being installed at financial institutions
expanding the company's presence into the retail credit card
market and international markets.
The following are the primary attributes of the Fraud Detection
and Proactive Risk Management Systems:
Flexible neural-network decision engine. The Company's software
implements a powerful, patented neural-network technology for
adaptive fraud detection that is accurate, fast, field-trainable
and operates in real-time. The neural-network and rule-bases are
provided through software that allows the Company's products to
be customized to fit the customers needs and profiles without
extensive custom programming. Unlike other rule-based systems,
the Company's products learn from the experience of the specific
customer accounts instead of only applying "industry" experience
to the customer's environment. The Company's software can be
rapidly trained to look for customer-specific fraud potential by
requiring as few as three training passes through a customer's
data. The system automatically adapts itself for problem
complexity and maximizes the detection of actual fraud while
minimizing false positive indications.
Automatic and ongoing learning ability. The Company's software
is trained to detect fraudulent patterns based upon the
customer's own historical data. Subsequent to installation, the
software continues to update its records for current patterns and
automatically modifies its predictive model to respond to changes
in the customer's user base and environment. Other competitive
systems may require extensive updating of the software to reflect
current industry or customer experience. The Company's software
allows the client to operate with the most current and customer-
specific database possible, with simple updates entirely under
client control.
Quick return on initial investment to customers. Due in part to
customizing the PRISM software to react based upon a client's
specific fraud experience, the product has resulted in fraud loss
savings of greater than 50% at G.E. Capital Consumer Financial
Services and over 50% in counterfeit detection at Europay
International S.A.. Performance at this level would provide a
customer experiencing average industry fraud losses a payback on
their first year installation and use fees of approximately four
to six months.
On-line, transaction-based capability. Nestor's software can
provide an immediate, situation-specific response to each
customer transaction. For example, the PRISM system can
immediately detect and report fraudulent activity within the
first one or two transactions, rather than within one or two days
of transactions.
Flexible client-server and operating solutions. Nestor's
solutions can be integrated into a customer's existing
environment or architecture. The Company's products are based
upon a distributed client-server architecture consisting of
operating components that operate on a wide range of industry
standard, client-server platforms, including the IBM, MVS/CICS,
Tandem's proprietary, fault tolerant Non Stop Kernel (NSK), UNIX
and Windows NT operating platforms. The Company believes that
its product is the only one available today that is adapted to
Tandem's NSK operating system, over which the Company estimates
more than 65% of the world-wide volume of ATM and Debit-card
transactions are processed. PRISM also provides an analysis
environment consisting of: a user-friendly, MS Windows-compatible
graphical user interface, an "open-systems" architecture that is
easily adapted to a client's working environment, fully
integrated work flow tools for enhanced productivity,
customizable reporting tools, and in-depth fraud analysis and
system maintenance tools.
Nestor's Fraud Detection and Risk Assessment Strategy
The Company's objectives are: to deliver high quality products
and services using proprietary neural-network technology to the
banking, retail, telecommunications and health-care management
industries, and to accrete a growing revenue stream from ongoing
product usage fees. The Company's strategy for achieving these
objectives includes the following key elements:
Expand current distribution network. The Company plans to expand
its worldwide direct sales, distribution and service forces. The
Company intends to continue developing domestic markets while
augmenting its international growth. Nestor has executed a
nonexclusive PRISM reseller agreement with CSK Corporation in
Japan during 1996 (See "Licensing, Joint Venture and Development
Agreements"), and is negotiating marketing agreements in Europe
and South America. The Company also intends to increase direct
sales efforts in North America through expansion of direct sales
staff and through marketing and service agreements with
established providers of products and services to its target
markets. On September 19, 1996, the Company signed a non-
exclusive license agreement with Applied Communications, Inc.
(ACI) under which ACI agreed to distribute PRISM throughout the
world. (See "Licensing, Joint Venture and Development
Agreements".)
Earn recurring revenues through on-going fees based upon product
usage. The Company's products provide immediate and ongoing
savings to the client through a reduction in the occurrence of
undetected fraud losses. The Company has priced its product to
include upfront fees for licensing and installation, thereby
providing an attractive payback of the customer's initial
investment as discussed above, and including an ongoing usage fee
based upon the number of customer transactions or accounts being
reviewed by the software. This ongoing revenue stream is
expected to grow as new customers install the product. Future
growth may also result from the customer's internal growth in
the number of transactions or accounts being reviewed by the
sofware.
Apply PRISM products to other markets. The Company believes
that many markets exist which are experiencing fraud type losses
and possess data characteristics similar to the financial
institution industry. The Company plans to extend the successes
of the PRISM product in credit-card fraud detection to other
areas with a high level of transactions and a history of similar
fraud-type loss experience. Some of these market opportunities
may include health-care claim payments and long-distance
telephone fraud. Nestor's strategy is to broaden its product
offerings to address these markets in conjunction with
development funding from strategic government and industry
sources.
Traffic Management Systems
TrafficVision is a combination of Company-developed software and
modular hardware components that provide for remote monitoring to
support traffic data collection and control of traffic flows.
The product is flexible and can be configured to a wide range of
road configurations, including open roads and intersections.
Features include remote video monitoring, real-time vehicle
classification, individual vehicle tracking, simultaneous
communication of video and traffic data over a single
communication network, and generation and logging to a database
of a variety of traffic-information measurements.
Historically, traffic sensing and control has been handled by
wire induction loops buried beneath the road surface. The system
provides basic information such as vehicle counts and speed (with
multiple loop configurations), in support of the function of
controlling traffic light signals when traffic is present. Such
loops experienced a 100% failure rate within the first 10 years
of operation. Replacement/repair is often not performed or
performed long after loop failure due to the high cost of digging
up the roadway.
TrafficVision provides all the benefits currently offered by loop
systems and substantial additional options that increase the
traffic controller's effectiveness in managing traffic
congestion, infractions, and accidents. The fact that
TrafficVision operates completely above ground aids in effective
maintenance. Additionally, the Company believes that the
technology will prove to be cost effective in comparison to loop
technology in applications of multiple-lane intersections.
TrafficVision is designed to incorporate the Company's Ni1000
Recognition Accelerator hardware chip (See "Ni1000 Chip" below.)
Development of a working prototype model commenced on September
1, 1995, in conjunction with a funding agreement with California
Institute of Technology Jet Propulsion Laboratory (see
"Licensing, Joint Venture, and Development Agreements"). The
Company expects the project to be completed in October 1996 and
field testing to be completed in fiscal 1997.
The following are the primary attributes of the Company's Traffic
Management Systems:
Accurate, real-time interpretation of traffic video images. The
Company has leveraged its patented neural-network decision engine
discussed above in Fraud Detection to the application of real-
time processing and learning in the context of video image
interpretation for traffic management and control. Prior
industry attempts to provide video-based detection of traffic
have not proven effective due to the difficulty of designing
robust detection algorithms under a variety of illumination,
visibility and traffic conditions, as well as the need to
implement such algorithms on cost-effective computing platforms
that provide real-time operation. The Company's neural-network
technology, combined with its Ni1000 chip ,discussed below, is
able to interpret video images accurately and respond in a real-
time environment.
Rapid deployment and increased services for customers. The
Company's software solutions are designed for rapid deployment
and to provide additional information to customers beyond that
delivered by current loop systems. TrafficVision is designed to
be installed entirely above ground and to tie into existing
customer hardware where appropriate. Maintenance becomes more
efficient than with underground loop systems. TrafficVision
systems allow the customer to obtain the same information as is
available through loop technology (e.g. vehicle count and
detection for signal control), and additional benefits such as
remote real-time video monitoring for traffic flow or incidence
response.
Leverages customer investment in video infrastructure. State
traffic departments are deploying roadside video cameras to
provide images of road and traffic conditions to better manage
traffic flows and incident response. Nestor's Traffic Monitoring
Systems are designed to support "dual use" of pan-tilt-zoom
equipped cameras for surveillance and traffic detection and
monitoring, thus leveraging the customer's investment in video
equipment. Additionally, Nestor's solution supports simultaneous
video and data communication over a single video communication
network, thus further leveraging the customer's video
infrastructure investment.
Compatibility with industry standard platforms. Nestor's traffic
monitoring solutions are architected around dominant industry-
standard platforms: namely, the Windows 95/NT operating system,
tools and communication support components and general "WinTel"
hardware specifications. This facilitates integration into a
customer's existing computing environment, leverages PC economics
to offer a compelling price/performance advantage and lowers
product engineering development costs. Additionally, the
Company's Traffic Monitoring Systems are designed to support the
emerging NTCIP communications standards being mandated in the
traffic detector industry. Further, roadside TrafficVision
detector stations will be compatible with existing and new
traffic controller hardware, such as the new CALTRANS 2070
controller standard.
Nestor's Traffic Management System Strategy
The Company's objectives are to be the high-quality supplier of
intelligent video-based traffic monitoring systems to replace
loop detectors at those sites where video has advantages in
either functionality or cost and to capture new traffic
monitoring applications beyond the capability of loop detector
systems. The Company's strategy for achieving these objectives
contains the following key elements:
Expand national and worldwide distribution. The Company plans to
target leading transportation departments (DOTs) through direct
sales to provide convincing demonstrations of TrafficVision's
superior performance, to create performance standards based upon
TrafficVision functionality and to generate a market pull that
will lead to volume distribution agreements with traffic
integrators and traffic equipment suppliers. The Company intends
to establish distribution agreements with foreign traffic
integrators, concentrating initially in the Far East where the
Company believes large investments are being planned in
transportation infrastructure.
Maintain technology leadership and patent protection in developed
solutions. As noted above, the Company has obtained patent
protection for its proprietary neural networks and hardware
systems (see "Patents") which the Company believes to be uniquely
suited to applications that require field trainability or self-
modification to adapt to new or changing patterns in the data.
The Ni1000 chip allows for high-speed processing applications,
such as video-image processing, on a personal computer platform.
The Company continues to maintain and explore new patent
protection rights for its proprietary software applications. The
Company was issued a new patent in fiscal 1996, and has an
application pending relating to its work in the traffic-
management areas.
Ni1000 Chip, PCI 4000 Recognition Accelerator Board and IBM ZISCT
Chip
Neural networks are inherently parallel systems whose operation,
until recently, has only been simulated on serial computers. The
relative slowness of serial simulation has prohibited the use of
neural networks in many high-value applications that require high-
speed learning and recognition. The Ni1000 Recognition
AcceleratorT chip is an embodiment of the Company's technology
that increases typical processing speeds by hundreds of times and
is expected to open these previously untapped markets to neural-
network solutions. Manufactured by Intel and introduced by the
Company in June 1994, the Ni1000 chip was developed with funding
by the Defense Advanced Projects Research Agency ("DARPA").
Commercial delivery of Ni1000 chips and Ni1000 Development
Systems began in June 1994. In April 1994, the Company and Intel
Corporation signed an agreement which provided the Company with
exclusive marketing rights to the Ni1000 Recognition Accelerator,
subject to certain minimum purchases of the Ni1000 Recognition
Accelerator by the Company. (See "Licensing, Joint Venture and
Development Agreements.")
In connection with the development of the Ni1000 Recognition
Accelerator, the Company and Intel were jointly named as winner
of the 1994 Discover Awards for Technological Innovation in the
category of Computer Hardware & Electronics. The Ni1000
Recognition Accelerator was selected by the editors of Electronic
Design News as a finalist in their 1994 "Innovation of The Year"
contest.
The Company's current development work in neural-network hardware
is centered on the development of a PC-compatible circuit-board
incorporating multiple Ni1000 Recognition Accelerators, and
associated development-environment software. Development of the
circuit board and software were funded, in part, by a contract
dated August 26, 1993, between the Company and Office of Naval
Research and administered by the Advanced Projects Research
Agency of the Department of Defense ("ARPA"). In connection with
such development work, the Company entered into a Technology
Development Subcontract with Alta Technology Corporation on
December 20, 1994 (see "Licensing, Joint Venture and Development
Agreements", below).
PCI 4000 Recognition Accelerator Board
An outgrowth of the Company's ARPA-funded development work is the
PCI 4000 Recognition AcceleratorT, which was developed
cooperatively with Alta Technology Corporation. The PCI 4000 is
a circuit board containing up to four Ni1000 Recognition
Accelerators and a Pentium controller, which is compatible with
any PC or workstation that provides PCI (Peripheral Component
Interconnect) support.
IBM ZISCT Chip
On January 31, 1996, the Company signed a technology licensing
agreement with IBM to use Nestor's pattern recognition
technology in an IBM developed neural-network semiconductor
device called the ZISCT (see "Licensing, Joint Venture and
Development Agreements"). The Company believes that the entry of
IBM into the field of neural-network applications may assist the
Company in the marketing of its own hardware components.
Intelligent Character Recognition Products
On June 11, 1996, the Company licensed the exclusive development
and marketing rights in its Intelligent Character-Recognition
("ICR") products (NestorReader, OmniTools, and N'Route) to
National Computer Systems, Inc. ("NCS"), and is no longer
involved in developing, packaging and marketing these products
(see "Licensing, Joint Venture and Development Agreements"). The
Company expects to receive royalties from the sales of these
products and any enhanced versions of these products by the
licensee. The following are the principal ICR products developed
and marketed by the Company through June 11, 1996, and marketed
by NCS since then:
NestorReaderT
NestorReader is a software product that is designed to perform
character recognition from images of hand-printed and machine-
printed characters in intelligent character recognition systems.
A principal application of NestorReader has been to replace the
human process of reading data from forms and entering the data
into computers by means of a keyboard. NestorReader is licensed
to original equipment manufacturers, value-added resellers and
systems integrators for integration into image-processing
systems. NestorReader extends the range of optical character
recognition to include hand print and faxed characters at a
price/performance ratio that the Company believes is unequaled by
competitive technologies. In optical character recognition,
existing techniques have successfully solved the problem of
reading conventional, clean, machine-printed characters.
Management believes that hand printed characters - with their
high degree of variability - and faxed characters, with their
high noise level, can only be read satisfactorily by more
powerful technologies like NestorReader.
OmniToolsT
OmniTools is a software product that enables corporate
applications developers to access the functionality of
NestorReader from within Windows applications without the need
for C programming. Developers need only use such familiar tools
as Visual Basic or applications macro languages including Visual
Basic for Applications. ICR solutions can thus be developed
from Access, Excel, Foxpro, Lotus 123, Paradox and other Windows
applications. The Company began marketing OmniTools in fiscal
1994.
N'Route
N'Route is a Windows end-user application that automatically
routes incoming faxes and scanned images directly to their
intended recipients. N'Route does this by recognizing the name
or other identifier written on a document and then routing the
document to its destination "mailbox" on Lotus Notes, cc:Mail or
Windows for Workgroups users with Microsoft Mail. Installation
and maintenance by a network administrator is by dialog boxes and
menus and requires no programming or character-recognition
expertise. In February 1995, N'Route was awarded the Imaging
Magazine "Product of The Year" award for 1994.
Sales, Marketing and Methods of Distribution
The Company sells and markets its software and services in North
America through a direct sales organization. Outside of North
America, the Company negotiates marketing agreements with various
industry service providers.
The Company's product lines are targeted toward large commercial
users (e.g., banks for the PRISM product), or federal and state
government agencies (e.g., Departments of Transportation for the
TrafficVision product). The products require technical
assistance through the sales and installation processes.
Accordingly, the Company maintains an in-house staff of engineers
to support the sales, installation, and customer-service
functions.
The Company's FDS and PRISM products are licensed directly by the
Company to financial institutions. The TrafficVision products
will be marketed directly to governmental traffic management
departments or their chosen integrators. The Ni1000 Recognition
Accelerator and the Ni1000 Development System are marketed
directly by the Company to developers of high-speed applications,
and are used in internally developed products. The Company's
Intelligent Character Recognition Products are marketed
exclusively by NCS. The Company obtains product inquiries from
product mailings, attendance at trade shows, media advertising
and trade-press coverage.
In financial services, the Company has in the past created custom
applications including risk assessment for bank-card fraud
detection, mortgage origination and insurance, consumer credit
and securities trading. Nestor's FDS and PRISM products are an
outgrowth of such development projects. In the United States and
Canada the Company markets FDS and PRISM directly. In the United
States and throughout the world, ACI, will package PRISM with its
BASE24 and TRANS24 products for worldwide distribution. In
Japan, custom financial applications are marketed through its
licensee, CSK Corporation. FDS and Prism are licensed to
applications developers in Europe and Japan under a standard, non-
transferable, non-exclusive software license limited to a single
computer. Developers of applications may not make, use or sell
multiple copies of such applications without entering into
additional licensing arrangements with the Company. Management
of the Company believes that the success of the PRISM and FDS
products will create a valuable franchise in each institution,
leading to extensions of the Company's technology to other risk-
assessment applications.
In fiscal 1996, National Computer Systems and Europay
International accounted for 30% and 13% of the Company's
revenues, respectively. In fiscal 1995, Europay International
accounted for 16% of the Company's revenues.
The Company is not required to maintain significant inventories
in order to deliver its products. The Company does not generally
grant payment terms to customers in excess of 90 days. At June
30, 1996, the Company had a backlog of approximately $408,140 in
undelivered development and installation contracts and
approximately $431,000 in prepaid royalties and engineering fees.
As of June 30, 1995, the Company had a backlog of approximately
$101,000 in undelivered development and installation contracts
and $439,000 of prepaid royalties and fees.
Technology
The Company's technology deals with the problem of pattern
recognition. When presented with a pattern of information, it
can be valuable to identify that pattern, whether it is a pattern
of fraudulent credit card use, fraudulent health care claims,
handwritten characters, vehicles in a traffic flow, and so on.
Several methods currently exist to address the problem of
processing information in order to recognize a pattern in the
information. Included among these are "expert" systems of rules,
and neural networks. The Company's products combine both of
these methods to optimize pattern recognition capabilities.
Rule-Based Technology. The Company's systems employ expert or
rule-based technology to define customer strategy, policy and
procedures in its products. Rule-based systems contain decision
trees of conclusions based on the existence of various
conditions. For example, a credit card transaction has been
authorized. To determine if that transaction was fraudulent and
whether or not an account should be investigated, the following
set of questions may be asked: has the card been reported lost or
stolen since the transaction occurred? If "yes", the transaction
equals "fraud"; if no, did the purchase amount exceed the credit
limit? If "yes", did the purchase occur less than one hour after
the previous purchase? If "yes, and so on. It is almost
impossible to cover all possibilities of combinations of
circumstances even with the most comprehensive suite of rules.
So, while allowing the implementation of select rules may be
beneficial, a decision based solely on rules may not always be
correct or practical.
Neural-Network Technology. Neural-networks simulate a virtual
network of interconnected units, processing data in parallel, and
communicating with each other at lightning speeds. A trained
neural-network expects input and then outputs a response: either
"unrecognized", "recognized", or "not sure". Exceeding the
capability of if-then-else conditional rules, the power of the
neural-networks is in their ability to accurately recognize
input, such as attempting to recognize characters from a scanned
handwritten sample, which is ill-defined (i.e. written in very
light pencil), affected by "noise" (i.e. smudged), or blatantly
unusual (i.e. overly large or small, or containing skewed
characters). Nestor, as the result of extensive research, has
created a proprietary neural-network technology referred to as
the Restricted Coulomb Energy ModelT (RCE) which has been granted
five patents.
The RCE model has many unique features. It has the fastest
learning and processing speed of any neural-network system. It
has been demonstrated that the RCE will learn to recognize
patterns orders of magnitude faster than a typical public domain
neural-network such as Back Propagation (BP). RCE has the
ability to add new features or classes without the need to
retrain and re-engineer the complete system. For example, using
BP, experts must re-engineer and completely retrain the entire
system if new features or classes are added. Re-engineering and
retraining is impractical for many real-world applications. RCE
is a dynamic configuration of the network so that it can scale
and configure itself to accommodate the complexity of a problem
and make the most efficient use of available hardware. With BP,
one must precisely engineer the number of neurons through
experimentation in order to use the technology, and a stable
solution is not guaranteed.
Nestor has also been granted a sixth patent for a multi-unit
system referred to as the Nestor Learning SystemT (NLS) which is
ideally suited for many real-world pattern recognition
applications. The NLS has a patented hierarchical, multi-network
system for better control and accuracy. This approach is
analogous to the way the human neural-network is believed to
function. The Company believes that the rapid model development
and operational flexibility afforded by its technology provides a
competitive advantage in the development of intelligent-decision
software solutions.
Research and Development Activities of the Company
The Company believes that its future depends upon its ability to
improve its current technologies and products and to develop new
technologies and products. The Company intends to pursue new and
enhanced technologies and products. The Company attempts to
locate external resources to assist in the costs of developing
new technologies or products, but may bear all or a portion of
such costs internally.
The Company's research is almost entirely applied research
intended to develop solutions to specific pattern-recognition
problems. This research has resulted in various patents relating
to improvements to the Company's basic technology (see
"Patents"). The Company received one new patent in fiscal 1996
and has one application pending as of June 30, 1996. These
improvements are incorporated into the Company's products.
The market for the Company's products may be impacted by changing
technologies. The Company's success will depend upon its ability
to maintain and enhance its current products and develop new
products in a timely and cost-effective manner that meets
changing market conditions. There can be no assurance that the
Company will be able to develop and market on a timely basis, if
at all, product enhancements or new products that respond to
changing market conditions or that will be accepted by customers.
Any failure by the Company to anticipate or to respond adequately
to changing market conditions, or any significant delays in
product development or introduction could have a material adverse
effect on the Company's business, financial condition and results
of operations.
The Company expended, in the fiscal years ended June 30, 1996,
1995, and 1994 respectively, $260,870, $1,563,836, and $1,146,789
in support of the various aspects of Company-sponsored research
and development, and $2,378,133, $1,195,201, and $641,579
respectively of customer-sponsored research.
Patents
The Company has continually sought and obtained patent protection
for its proprietary neural networks and systems, which have as a
principal feature rapid learning from a relatively small number
of examples. The Company believes that this capability makes the
Company's technology uniquely suited to applications that require
field trainability or self-modification to adapt to new or
changing patterns in the data. The Company's patents also cover
multiple-neural-network systems, which enable the company to
develop products that combine high accuracy with high processing
speeds; and the Company's RCE neural network, which exhibits
rapid learning and minimizes the internal connections needed for
its functioning. This sparse connectivity has enabled the
Company to develop, with Intel Corporation, a neural-network
integrated circuit (the Ni1000 Recognition AcceleratorT chip)
containing many more nodes than has been possible with other
designs.
The Company owns ten United States patents and twenty-three
foreign patents issued in eleven countries. In addition, there
is one application pending in the United States, and there are
five applications pending in various foreign countries, as of
June 30, 1996. The foreign patents and patent applications
correspond to one or more of the United States patents.
The Company believes that seven of its United States patents, and
eleven corresponding foreign patents, are material to its
business. These United States patents expire at various times
from 1998 to 2008. The corresponding foreign patents expire at
various times from 1995 to 2008. The following table lists the
Company's material United States patents:
Patent Number Title Date of Issue Year of
Expiration
4,254,474 An Information Processing System March 3, 1981 1998
Using Threshold Passive
Modification
4,326,259 Self-organizing General Pattern April 20, 1982 1999
Class Separator and Identifier
4,760,604 Parallel, Multi-unit, Adaptive, July 26, 1988 2005
Nonlinear Pattern Class Separator
and Identifier
4,897,811 N-Dimensional Coulomb Neural January 30, 1990 2007
Network Which Provides for
Cumulative Learning of Internal
Representations
4,958,375 Parallel, Multi-unit, Adaptive September 18, 1991 2008
Pattern Classification System
Using Inter-unit Correlations And
An Intra-class Separator
Methodology
5,054,093 Parallel, Multi-unit, Adaptive, October 1, 1991 2008
Nonlinear Pattern Class Separator
and Identifier
5,479,574 Method and Apparatus for Adaptive December 26, 1995 2012
Classification
Competition
In the field of fraud-detection and risk-assessment systems, the
Company encounters competition from a number of sources,
including (a) other software companies, (b) companies' internal
MIS departments, (c) network and service providers, and (d)
neural-network tool suppliers. In the fraud-detection market,
the Company has experienced competition from Fair, Isaac & Co.,
HNC Software, Inc., IBM, NeuralTech Inc., Neuralware, Inc., Visa
International and others. The Company's fraud detection product
also competes against other methods of preventing credit-card
fraud, such as card-activation programs, credit cards that
contain the cardholder's photograph, smart cards and other card
authorization techniques. The introduction of these and other
new technologies will result in increased competition for the
Company and its products.
In the field of traffic management systems, the Company's
TrafficVision products (see "Recent Product Developments") face
competition primarily from standard providers of existing loop
system products. Other technologies exist from various sources
that provide some of the basic traffic management functions
provided by the loop system, such as Microwave, Ultrasonic,
Infrared, and Acoustic. These technologies have limitations and
do not provide the full range of options available through
TrafficVision. Video-based systems are also available through
other companies such as Econolite, Peek Traffic, Odetics,
Traficon, Siemens, and Rockwell International. However, the
Company believes that the platform on which these video-based
products operate does not provide the image processing
capabilities possessed by TrafficVision and the Ni1000
Recognition Accelerator Chip.
In the field of high-speed processing, the Company's Ni1000
Recognition Accelerator products (see "Recent Product
Developments", above) faces competition primarily from Adaptive
Solutions, Inc., whose CNAPS board contains proprietary parallel-
processing integrated circuits. The Company believes that the
CNAPS board is a general-purpose parallel processor that is not
optimized for pattern classification. The Company further
believes that the CNAPS board and associated software have a list
price that is approximately 50% higher than similar
configurations of the Company's Ni1000 products, and that the
Company's hardware products typically operate at speeds 10 to 50
times faster than the CNAPS product in pattern-classification
applications.
Most of the Company's competitors have significantly greater
financial, marketing and other resources than the Company. As a
result, they may be able to respond more quickly to new or
emerging technologies or to devote greater resources to the
development, promotion and sale of their products than the
Company. Competitive pressures faced by the Company may
materially adversely affect its business, financial condition and
results of operations.
Employees
As of June 30, 1996, the Company had 31 full-time employees,
including 22 in product development, 3 in sales and marketing
and 6 in finance and administration. Three of these employees
have earned Ph.D. degrees. One of the Company's current
directors (and a founder of Nestor Associates) received the Nobel
Prize in Physics in 1972. All of these employees are located in
the United States. None of the Company's employees is
represented by a labor union. The Company has experienced no
work stoppages and believes its employee relationships are
generally good.
The Company's success depends to a significant degree upon the
continued employment of the Company's key personnel.
Accordingly, the loss of any of the Company's key personnel could
have a materially adverse effect on the Company's business,
financial condition and results of operations. No employee
currently has an employment contract in place with the Company.
The Company believes its future success will depend upon its
ability to attract and retain industry-skilled managerial,
engineering, and sales personnel, for whom the competition is
intense. In the past, the Company has experienced difficulty in
recruiting a sufficient number of qualified sales people. In
addition, competitors may attempt to recruit the Company's key
employees. There can be no assurance that the Company will be
successful in attracting, assimilating and retaining such
qualified personnel, and the failure to attract, assimilate and
retain key personnel could have a materially adverse effect on
the Company's business, financial condition and results of
operations.
Licensing, Joint Venture and Development Agreements
The Company seeks to enter into license agreements and research
and development contracts in order to obtain greater market
penetration and additional funding of the development of its
technology in specific fields of use.
Applied Communications, Inc. (ACI)
On September 19, 1996, the Company entered into a non-exclusive
license agreement with ACI which grants to ACI the right to
integrate PRISM with ACI's products and distribute on a worldwide
basis. ACI provides authorization and transaction processing
software to more than 475 customers throughout the world. The
Company will receive royalties based on PRISM license,
engineering and ongoing use fees received from ACI sublicenses.
National Computer Systems, Inc. (NCS)
On June 11, 1996, the Company entered into an exclusive Licensing
Agreement and an Asset Purchase Agreement with NCS transferring
the development, production, and marketing rights of the
Company's Intelligent Character Recognition (ICR) products to
NCS. The Company received $1,400,000 as an initial license fee
pursuant to the Licensing Agreement, and expects to receive
royalties on future sales of the product by NCS. Minimum annual
royalties range from $160,000 in 1997 to $350,000 in 2001 and
beyond. If NCS terminates its exclusive rights under the
contract, minimum royalty payments would not be required
subsequent to such termination.
The Asset Purchase Agreement transferred tangible and intangible
assets used exclusively in the ICR business to NCS for $300,000.
The initial license fee and asset sale proceeds are recognized as
revenues in Fiscal 1996.
IBM ZISCT
On January 31, 1996, the Company signed a technology licensing
agreement with IBM to use Nestor's pattern recognition technology
in an IBM developed neural network semiconductor device. IBM has
the right to use the technology in the IBM ZISC (zero instruction
set computing) digital integrated Neural Network chip and in
future versions of the chip and related product enhancements.
The IBM ZISC chip is expected to enable such complex mission-
critical applications as image recognition for satellite,
military and medical operations, financial data management and
risk assessment, automotive applications, as well as highly
sensitive identification systems such as sonar and fingerprinting
and other crime-scene type analysis. The Company will receive
royalties from the sales of the chip and related products.
California Institute of Technology Jet Propulsion Laboratory
(JPL)
On September 1, 1995, the Company commenced a partially funded
development agreement with JPL to design a Traffic Surveillance
and Detection Technology capable of directly measuring desired
traffic parameters simultaneously, combined with higher accuracy
and at a lower cost than available with current technology. The
Company is applying its expertise in rapid pattern recognition
and neural network designs to the project. The prototype and
initial program is scheduled to be completed in October 1996.
The total value of the contract is $597,000, and revenues
totaling $378,000 have been recognized as of June 30, 1996.
DARPA/ARPA
The Company entered into a development agreement dated March 13,
1990 with DARPA for the development of a neural-network chip
prototype embodying the Company's proprietary technology. On
April 21, 1992 the Company and DARPA agreed to increase the
contract to approximately $1,630,000 and extended the expected
completion date to May 1993. In May 1990, the Company signed a
Technology Development Agreement with Intel Corporation, under
which Intel agreed to provide the design and manufacturing
capabilities to satisfy the requirements of the contract with
DARPA. The total cost to the Company of the subcontract with
Intel is $750,000. On April 30, 1992, the cost of the
subcontract was increased to $1,050,000. During the year ended
June 30, 1993 the Company included in revenue approximately
$436,000 relating to its work under the DARPA contract.
On August 26, 1993, the Company entered into a follow-on program
with ARPA (formerly known as DARPA) to design and produce a PC
compatible application design and development environment,
comprising both hardware and software, which will enable users to
incorporate the Ni1000 into products. The total value of this
contract, which was completed in December 1995, was $776,167, of
which approximately $423,000 was realized in fiscal 1994.
CSK
On June 13, 1996, the Company executed a nonexclusive PRISM
Reseller Agreement with CSK Corporation to market, install,
maintain, train and support the PRISM product in Japan. The
agreement is for a term of two years.
Intel Corporation
On October 15, 1993, the Company and Intel Corporation had
entered into a license agreement, pursuant to which Intel
acquired a non-exclusive right to develop and sell products
incorporating the Company's technology. On April 7, 1994, the
license agreement was amended to grant to the Company exclusive
marketing rights to the Ni1000 Recognition Accelerator Chip,
which Intel will manufacture and sell to the Company subject to
the Company's meeting certain minimum purchase requirements. If
such minimum purchase requirements are not met by the Company,
the Company's right to market the Ni1000 Recognition Accelerator
Chip will become non-exclusive. The Company placed the first
required minimum purchase order in June 1995 and has maintained
minimum order requirements.
Alta Technology
On December 20, 1994, the Company entered into a Technology
Development Subcontract ("the Subcontract") with Alta Technology
Corporation ("Alta") relating to the development of a multi-chip
Ni1000 circuit board. Pursuant to the Subcontract, the Company
and Alta granted to each other licenses to use certain of their
respective proprietary technologies that are required for
manufacturing the Ni1000 circuit board, including Ni1000 boards
to be delivered to ARPA under a contract between the Company and
the Office of Naval Research. The Subcontract is in the amount
of $154,200 payable by the Company to Alta, upon receipt by the
Company of payments by ARPA, during the period ending May 31,
1995. As of June 30, 1995, the Alta subcontract had been re-
negotiated to $194,200, and Alta had billed the Company in the
aggregate amount of $198,000. Of the total ARPA contract of
$776,167, the Company had billed $765,841 to ARPA at June 30,
1995, and the remainder in 1996.
Recent Financing
On August 4, 1994, Wand Partners, Inc. purchased from the
Company, for an aggregate purchase price of $1,500,000, (i) 1,500
shares of Series C Convertible Preferred Stock of the Company
which are presently convertible into 1,000,000 shares of Common
Stock of the Company, and (ii) a warrant to purchase 1,000,000
shares of Common Stock of the Company at a price of $1.50 per
share ("Wand Warrants"). The net proceeds to the Company of this
transaction, after expenses, were $1,470,000.
Pursuant to a Standby Financing and Purchase Agreement dated
March 16, 1995, Wand loaned to the Company the sum of $1,200,000
evidenced by a promissory note (the "Note") which bears interest
at the rate of 10% per annum payable in shares of Common Stock of
the Company valued at $1.00 per share until September 15, 1995
when the Note matures. On June 30, 1995, the Company and Wand
entered into a First Amended and Restated Standby Financing and
Purchase Agreement, pursuant to which Wand made an additional
loan to the Company bringing the principal amount of the Note to
$1,700,000 and extended the term of the note to October 15, 1995.
The Note is callable by the holder at any time up to the
commencement of the rights offering in the event of a material
adverse change in the condition or prospects of the Company.
Wand has agreed to waive the Rights that it otherwise would have
been entitled to receive in the rights offering to shareholders
described below. Instead, upon the conclusion of the rights
offering, Wand has agreed to cancel and surrender the Note to the
Company and to apply the principal amount of the Note, and an
additional $300,000 first to the purchase of up to a maximum of
220,000 Unregistered Units (in proportion to the Units purchased
by other stockholders of the Company pursuant to this offering)
and then to the purchase of additional shares of Series C
Convertible Preferred Stock. The terms and conditions of such
Series C Convertible Preferred Stock are the same as the 1,500
shares of Series C Convertible Preferred Stock previously owned
by Wand. Concurrently with the purchase by Wand of such
additional shares of Series C Convertible Preferred Stock, the
Company reduced the exercise price of the Wand Warrants from
$1.50 per share to $0.65 per share. The Company will record an
expense as a result of the reduction in exercise price upon
exercise of warrants. The expense will represent the difference
between the market value of the Company's Common Stock being
acquired and the aggregate reduced exercise price of the warrants
on the date of exercise, but not more than the reduction in
exercise price. The maximum such expense to be recorded will be
$850,000.
As consideration for this commitment, the Company has issued to
Wand as a commitment fee 100,000 shares of the Common Stock of
the Company, the market value of which was charged to operating
expenses in 1995. Upon completion of the offering and the
conversion of the Note as described above, the Company has agreed
to issue to Wand 700,000 ten-year warrants to purchase shares of
the Common Stock of the Company at $1.00 per share, and the
difference between the market value of the underlying Common
Stock of the Company and the aggregate exercise price of such
warrants was charged to operating expenses at the time of
issuance of such warrants in the amount of $131,250 during fiscal
1996.
On August 16, 1995, a registration statement filed by the Company
with the Securities and Exchange Commission became effective.
The registration statement related to the shares received upon
the exercise of warrants in April 1994 as described above, and to
the shares underlying certain warrants issued to the Selling
Agent of the first private placement described above. The
registration statement was filed principally to effect a rights
offering to shareholders of the Company, each of whom was granted
the right to purchase one Unit for each five shares of Common
Stock owned or into which convertible preferred stock was
convertible. A Unit consisted of one share of Series D
Convertible Preferred Stock, which is convertible into Common
Stock at any time after January 1, 1996, and a warrant to
purchase one-half share of Common Stock at a purchase price of
$2.00 per share. Such warrants are exercisable immediately and
for a term of three years after the effective date of the
registration statement.
At June 30, 1995, there were outstanding 1,500 shares of Series C
Convertible Preferred Stock. In early October 1995, Wand
exchanged certain Notes payable for an additional 1,970 shares of
Series C Preferred Stock. On January 31, 1996, Wand exchanged
all of its Series C Convertible Preferred Stock for 1,444 shares
of Series E Convertible Preferred Stock and 2,026 shares of
Series G Convertible Preferred Stock. In addition, on January
31, 1996, Wand purchased 599 shares of Series F Convertible
Preferred Stock for a total of $599,000. On March 7, 1996, Wand
purchased 777 shares of Series G Convertible Preferred Stock for
a total of $777,000. See below and Item III, Financial
Statements and Footnotes.
Series E,F,G and H Convertible Preferred Stock
Each share of Series F and G Preferred Stock is convertible at
the option of the holder at any time after June 30, 1996 into
shares of Common Stock at the conversion price of $1.25 per
share, subject to adjustment. Each share of Series E and H
Preferred Stock is convertible at the option of the holder at any
time and from time to time into shares of Common Stock at the
conversion price of (a) $1.50 per share subject to adjustment
prior to August 1, 2004 or (b) on or after August 1, 2004 at a
conversion price which is the lower of $1.00 or the conversion
price in effect pursuant to (a).
Except as provided herein, any holder of Series E and G Preferred
Stock that is subject to the Bank Holding Company Act of 1956
("BHCA Holder"), as amended, shall have no voting rights. Each
holder of Series E and G Preferred Stock that is not a BHCA
Holder shall be entitled to vote on all matters as to which
stockholders of the Company are entitled to vote, and each such
holder shall be entitled to cast a number of votes equal to the
greatest number of whole shares of Common Stock into which such
holder's shares of Series E and G Preferred Stock could be
converted. The holders of the Series F and H Convertible
Preferred Stock are entitled to one vote for each share of Common
Stock into which the shares are convertible.
In the event the Company is in default with respect to the
payment of (i) two consecutive cash dividends after the
"Restricted Period" as hereinafter defined or (ii) two dividends
within any six consecutive dividend periods the holders of the
Series F and G Preferred Stock shall have the right to elect two
directors and the holders of the Series E and H Preferred Stock
shall have the right to elect four directors for so long as the
default continues. In the event the Company is in default with
respect to the payment of (i) four consecutive cash dividends
after the Restricted Period as hereinafter defined or (ii) four
dividend payments within any eight consecutive quarterly dividend
periods, the holders of the Series F and G shall have the right
to elect four directors and the holders of the Series E and H
Preferred Stock shall have the right to elect eight directors for
so long as the default continues.
In the event the Company violates the provision of, or is in
default under the terms of any loan agreement or in the event a
judgment is entered against the Company or any subsidiary in the
amount of $50,000 or more, the holders of the Series F and G
Convertible Preferred Stock shall have the right to elect four
directors and the holders of the Series E and H Preferred Stock
shall have the right to elect eight directors for so long as the
default continues.
The holders of the Series F and G Preferred Stock, except during
the Restricted Period, are entitled to receive out of funds of
the Company legally available for such purpose as and when
declared by the Board of Directors of the Company quarterly
dividends in cash at a rate of nine percent (9%) compounded daily
per annum of the stated par value per share ($1,000 on original
issuance) of Series F and G Preferred Stocks. Dividends shall
accrue, be accumulated and added to the stated value whether or
not declared. So long as any shares of Series F and G Preferred
Stock are outstanding, the Company shall not declare or pay any
dividends on any outstanding Common or Preferred Stock, other
than the Series F and G Preferred Stock. The Restricted Period
as it relates to the payment of dividends on the Series F and G
Preferred Stock means a period beginning on the date of issuance
of the Series F and G Preferred Stock and ending on September 30,
1997. While no dividends are payable during the Restricted
Period, they will accrue and accumulate during the Restricted
Period.
The holders of the Series E and H Preferred Stock, except during
the Restricted Period, are entitled to receive out of funds of
the Company legally available for such purpose as and when
declared by the Board of Directors of the Company quarterly
dividends in cash at a rate of seven percent (7%) compounded
daily per annum of the stated par value per share ($1,000 on
original issuance) of Series E and H Preferred Stocks. Dividends
shall accrue, be accumulated and added to the stated value
whether or not declared. So long as any shares of Series E and H
Preferred Stock are outstanding, the Company shall not declare or
pay any dividends on any outstanding Common or Preferred Stock,
other than the Series F and G Preferred Stock. The Restricted
Period as it relates to the payment of dividends on the Series E
and H Preferred Stock means a period beginning on the date of
issuance of the Series E and H Preferred Stock and ending on the
earlier of (a) the first day of the calendar quarter in which the
Company first pays cash dividends on its Common Stock or (b) June
30, 1998. While no dividends are payable during the Restricted
Period, they will accrue and accumulate during the Restricted
Period.
The Company is obligated to redeem all outstanding shares of
Series E, F, G and H Preferred Stock outstanding at the stated
value plus accrued dividends on August 1, 2004. The holders of
the Series E, F, G and H Preferred Stock have the right to
require that the Company redeem, to the extent the Company may
lawfully do so, all or a portion of the then outstanding shares
of Series E, F, G and H Convertible Preferred Stock at the stated
value plus accrued interest and unpaid dividends in the event of
a merger, reorganization, transfer of the majority of the voting
securities of the Company, or sale of more than 25% of the assets
of the Company.
ITEM 2. Properties.
The Company leases offices and research and development
facilities, consisting of approximately 10,000 square feet,
located at One Richmond Square, Providence, Rhode Island 02906,
for which the annual base rental is $134,993. The Company
believes these facilities will be adequate to serve its needs in
the foreseeable future.
ITEM 3. Legal Proceedings.
There are no material pending legal proceedings as of the date of
this filing.
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 fiscal year ended June 30, 1996.
ITEM 5. Market for Registrant's Common Stock
and Related Securityholder Matters
The Company's common stock was first offered to the public in
December, 1983. The principal market in which the Company's
common stock is traded is the over-the-counter market. The
quotations below reflect inter-dealers prices, and do not include
retail markups, markdown or commissions and may not necessarily
represent actual transactions. The shares of common stock are
traded in the over-the-counter market and bear the symbol "NEST".
Low Bid High Ask
Year Ended June 30, 1996
1st Quarter 1 1/4 1 11/16
2nd Quarter 9/16 1 3/8
3rd Quarter 23/32 2 3/16
4th Quarter 1 3/8 3 3/16
Year Ended June 30, 1995
1st Quarter 1 2-3/8
2nd Quarter 5/8 1-1/4
3rd Quarter 1/2 3-3/8
4th Quarter 1-1/4 2-1/2
As at September 17, 1996, the number of holders of record of the
issued and outstanding common stock of the Company was 425.
The Company has not declared any cash dividends with respect to
its common stock since its formation.
ITEM 6. Selected Financial Data
Years Ended June 30,
1996 1995 1994 1993 1992
Operating revenue $5,461,580 $ 3,195,563 $ 2,230,474 $ 1,849,104 $ 2,219,425
Other income
(expense) $ 39,950 $ (221,024) $ (282,418) $ (27,459) $ 3,137
Net income
(loss) $ 12,690 $(3,457,422) $(1,758,584) $(1,613,565) $(1,814,856)
Earnings per share
Weighted
number of
outstanding
shares 7,847,510 7,411,502 6,840,407 6,801,929 6,788,006
Income (loss)
per share $ .00 $ (.47) $ (.26) $ (.22) $(.27)
SELECTED BALANCE SHEET DATA:
Total assets $3,351,871 $ 1,812,495 $1,096,314 $ 935,337 $1,793,782
Working capital $1,983,661 $(1,882,875) $ 220,243 $ 131,827 $ 535,126
Long-term
Capital leases $ 9,455 $ --- $ 3,363 $ 5,413 $ ---
Deferred income $ 430,899 $ 438,896 $ 954,491 $ 954,491 $ 954,491
Prior period Selected Financial Data has been reclassified to conform to
1996 classifications.
ITEM 7: Management's Discussion and Analysis
Liquidity and Capital Resources
Cash Position and Working Capital
The Company had cash and short term investments of approximately
$2,013,000 at June 30, 1996; $452,000 at June 30, 1995; and
$416,000 at June 30, 1994. At June 30, 1996, the Company had
working capital of $1,983,000, as compared with a working-capital
deficiency of $1,882,000 at June 30, 1995. The increase in
working capital reflects the net of several effects: an increase
in cash, resulting from the sale of stock, less the net cash
used in operations (See "Results of Operations"); and the
conversion of current Notes payable to Redeemable convertible
preferred stock (See Note 18 to "Notes to Consolidated Financial
Statements").
The Company had a negative net worth of $3,433,000 at June 30,
1996, as compared with negative net worth of $3,663,000 at June
30, 1995.
Rights Offering and Sale of Series D Preferred Stock
On August 16, 1995, a registration statement of the Company
relating primarily to rights granted to the Company's
shareholders became effective. Each right enabled the holder to
purchase a Unit consisting of one share of Series D Convertible
Preferred Stock, convertible into one share of Common Stock after
January 1, 1996 and one warrant to purchase one-half share of
Common Stock for three years after the effective date of the
registration statement at a price of $2 per share. (See Notes 15
and 18 to "Notes to Consolidated Financial Statements.")
Gross proceeds of the Rights Offering, which closed on September
29, 1995, totaled $285,823. In early October the Company
received the proceeds of the offering and issued the stock.
Costs of the offering, which were charged to additional paid-in
capital, totaled approximately $136,000.
Sale of Redeemable Preferred Stock
On January 31, 1996, the Company sold to Wand Partners $599,000
of Series F Convertible Preferred Stock and warrants to purchase
173,710 shares of Common Stock. On March 7, 1996, the Company
sold to Wand Partners $777,000 of Series G Convertible Preferred
Stock and warrants to purchase 225,330 shares of Common Stock.
Each share of Series F and G Preferred stock is convertible,
after June 30, 1996, into Common Stock at the rate of $1.25 per
share of Common Stock, subject to adjustment. The warrants are
exercisable at $1.25, subject to adjustment. (See Note 16 to
"Notes to Consolidated Financial Statements.")
Management believes that the Company's revenues will generate
sufficient liquidity, when combined with its liquid assets as at
June 30, 1996, to meet the Company's anticipated cash
requirements through the end of the fiscal year ending June 30,
1997. If the Company does not realize revenues sufficient to
maintain its operation at the current level, management of the
Company would curtail certain of the Company's operations until
additional funds become available through investment or revenues.
Deferred Income
Operations of the Company have been partly funded by prepayments
under engineering contracts and licenses of the Company's
technology. Such prepayments are recognized as revenue under the
percentage-of-completion method as engineering is completed or
delivery obligations are fulfilled. The Company bases its
estimate of the percentage of completion on the amount of labor
applied to a given project, compared with the estimated total
amount of labor required. The remainder of such prepaid revenue
is reflected on the Company's balance sheet as deferred income,
and is treated as a liability. Total deferred income was
$517,000 at June 30, 1996, as compared with $516,000 at June 30,
1995.
Future Commitments
The Company purchased additional computers and related equipment
during the fiscal years ended June 30, 1996 and 1995, and valued
its investments in computers and related equipment (net of
depreciation) at $219,788 at June 30, 1996. The Company has no
material commitments for capital expenditures although management
expects that the Company may make future commitments for the
purchase of additional computing and related equipment, for
development of hardware, for consulting and for promotional and
marketing expenses.
The company has no material commitments other than a commitment
to purchase from Intel Corporation a supply of Ni1000 Recognition
Accelerator chips. The Company placed a purchase order in the
amount of $195,000 with Intel Corporation in June 1996, and
expects to take delivery of this order during the third quarter
of the fiscal year that began on July 1, 1996.
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
For its fiscal year ended June 30, 1996, the Company realized a
71% increase in revenues over the prior fiscal year while
expenses decreased 15% from the prior year, resulting in a profit
of $12,688 after taxes.
Included in Total Revenues for the fiscal year ended June 30,
1996 is an initial license fee of $1,400,000 that the Company
received pursuant to a Licensing Agreement signed in June 1996.
On June 11, 1996, the Company entered into an exclusive Licensing
Agreement and an Asset Purchase Agreement with National Computer
Systems, Inc. ("NCS") transferring the development, production,
and marketing rights of the Company's Intelligent Character
Recognition ("ICR") products to NCS. In addition to the initial
license fee, the Company will receive royalties on future sales
of the products by NCS. Minimum annual royalties range from
$160,000 in 1997 to $350,000 in 2001 and beyond.
The Asset Purchase Agreement transferred tangible and intangible
assets used exclusively in the ICR business to NCS for $300,000.
The net gain on the sale of these assets was approximately
$213,000 and is recognized as "Other income" in the quarter ended
June 30, 1996.
Revenues
The Company realized revenues from operations of $5,461,000
during the fiscal year ended June 30, 1996, including the
$1,400,000 license fee from NCS, as compared with $3,195,000
realized during fiscal 1995, and $2,230,000 realized during
fiscal 1994.
Total revenues for the fiscal year ended June 30, 1994 included
$300,000 of revenue received pursuant to an agreement with Intel
Corporation relating to the acquisition by the Company of
exclusive marketing rights to the Ni1000 Recognition Accelerator.
As part of this agreement, the Company agreed to a price increase
for the Ni1000 Recognition Accelerator and agreed to make minimum
purchases over a two-year period in order to retain its exclusive
marketing rights. Intel delivered to the Company certain
marketing materials; assigned to the Company its interest in
future accounts receivable under the beta program for the Ni1000
Recognition Accelerator; and, as additional consideration for the
Company's entering into the agreement, paid to the Company the
sum of $300,000. As there were no specific performance
requirements or identifiable costs associated with this payment
and the Company had no liability to return any part of such
payment, the Company recorded this payment as revenue, which
revenue is non-recurring.
Software Licensing
The Company's software licensing revenues in fiscal 1996 derived
primarily from licenses of its ICR products. Licensing fee
revenues totaled $2,825,000 in the fiscal year ending June 30,
1996, including the $1,400,000 license fee from NCS, as compared
with $1,714,000 in the prior fiscal year and $1,349,000 in the
fiscal year ended June 30, 1994. The increase in revenues from
1994 to 1995 was driven by an increase in unit volume. The
increase in revenues from 1995 to 1996 is attributable to the
initial license fee paid by NCS; excluding that transaction,
license fee revenues decreased from 1995 to 1996 as a result of
lower unit volume.
For 1997, the Company will not receive ICR licensing fees but
expects to receive royalties from NCS on future sales of the ICR
products by NCS under the Licensing Agreement signed in June
1996. The minimum annual royalty for 1997 is $160,000. (See
"Expenses", below, for a discussion of the effect on the
Company's expenses of this licensing arrangement.)
Engineering Services
Revenues from engineering contracts totaled $2,378,000 in fiscal
1996, as compared with $1,195,000 in the prior year and $641,000
in fiscal 1994. The components of these revenues are separately
analyzed below.
During the fiscal year ended June 30, 1996, the Company realized
revenues from engineering contracts with industrial and
commercial customers of approximately $324,000, as compared with
$81,000 during the preceding year and $24,000 during fiscal 1994.
The increase in these revenues from 1995 to 1996 reflects a shift
in the allocation of engineering efforts from internally funded
product-development efforts to customer-funded projects, in part
intended to offset reduced ICR licensing revenues.
During fiscal 1996, customizing the Company's fraud-detection
system produced engineering revenues of approximately $1,593,000,
as compared with $771,000 in fiscal 1995 and $236,000 in fiscal
1994.
The Company's contracts with the Advanced Research Projects
Agency (ARPA), formerly called the Defense Advanced Research
Projects Agency, require engineering services rendered by the
Company to develop a generic commercial application of the
Company's technology to high-speed pattern recognition through
the creation of an integrated circuit, associated circuit boards,
and supporting development software. The Company has two
contracts with ARPA. The first contract, which was signed in
April 1990, is in the amount of $1,630,000; as of June 30, 1996,
approximately $1,623,000 had been earned. The second contract,
signed August 26, 1993, is in the amount of $776,000; as of June
30, 1996, approximately $773,000 had been earned.
On September 1, 1995, the Company signed a contract with the Jet
Propulsion Laboratory (JPL) to develop a prototype sensor system
designed for vehicular-traffic surveillance and detection. The
contract, valued at approximately $597,000, is expected to run
for 13 months from September 1995. The terms of the ARPA and JPL
contracts call for delivery of prototype products, but do not
specify any subsequent purchasing or licensing provisions.
During the fiscal year ended June 30, 1996, revenues from the
Company's government contracts totaled $378,000, as compared with
such revenues of $342,000 in the prior year and $423,000 of such
revenues in the fiscal year ended June 30, 1994.
Tangible Product Sales
The tangible products currently sold by the Company are based
upon the Company's Ni1000 Recognition Accelerator Chip, which is
marketed along with development software that enables customers
to develop high-speed recognition applications. Revenues from
the Company's Ni1000 Development System totaled $257,000 in the
fiscal year ended June 30, 1996, as compared with $286,000 in the
preceding year and $239,000 in fiscal 1994. In April 1994, the
Company and Intel Corporation signed an agreement which provided
the Company with exclusive marketing rights to the Ni1000
Recognition Accelerator, subject to the Company's being obligated
to make minimum purchases of the Ni1000 Recognition Accelerator
in the amount of $97,500 to be ordered by June 30, 1995, and
$195,000 to be ordered by June 30, 1996. The Company has placed
orders for the required minimum purchases.
Expenses
Total Expenses - consisting of operations, selling and marketing,
and general and administrative expenses - amounted to $5,488,000
for the fiscal year ended June 30, 1996, as compared with
$6,431,000 in the prior year, and $3,706,000 in 1994.
Expenses in fiscal 1995 and 1994 reflect the reclassification of
$210,500 and $287,969, respectively, to "Other income (expense)".
These amounts represent non-cash charges relating to the issuance
of stock or exercise of warrants at below-market prices.
Included in fiscal 1996 expenses are approximately $1,997,000 of
expenses attributable to the ICR products, which were licensed to
NCS in June 1996. Most of the expenses associated with the ICR
products will no longer be incurred by the Company as NCS hired
most of the staff assigned to development, sales, and support of
the ICR products.
Management expects expenses to decrease initially in fiscal 1997
reflecting the License of the ICR products to NCS. However, as
the Company invests in existing and new product opportunities,
management expects expenses to increase.
The decrease in expenses from 1995 to 1996 reflects both staff
attrition and management's efforts to reduce expenses. The
majority of the decrease in total expenses derived from decreases
in promotion, salaries and consulting, recruiting and
subcontracting.
Labor costs continue to be the Company's single greatest expense
category. During fiscal 1996, the Company paid $3,103,000 for
wages and consulting fees, as compared with $3,302,000 in the
prior year and $1,955,000 in fiscal 1994. The decrease from 1995
to 1996 reflects a decrease in staffing: full-time employees
totaled 33 at June 30, 1996, as compared with 53 at June 30 1995,
and 31 at June 30, 1994. In mid-June 1996, NCS hired 14 full-
time employees who had been employed by the Company prior to
signing the License agreement with NCS. Immediately prior to the
transfer of these employees, the Company had 47 employees.
Operating Expenses
Operating expenses, which are primarily labor costs related to
product development, engineering and sales totaled $5,488,000 for
the fiscal year ended June 30, 1996, as compared with $6,431,000
in the prior year and $3,706,000 in fiscal 1994.
Operating costs and expenses related to the production of
revenues from software licensing totaled $686,000 in fiscal 1996,
as compared with $1,979,000 in the preceding year and $1,159,000
in fiscal 1994. The decrease in such costs from 1995 to 1996
reflects management's decision to shift engineering resources
from internally funded product-development efforts to customer-
funded engineering projects.
Costs related to engineering services totaled $1,833,000 in the
fiscal year ended June 1995, as compared to $665,000 in the prior
year and $628,000 in fiscal 1994. The increase of these costs
reflects the increase in engineering services revenues.
The Company's expenditures for research and development were
$2,639,000 in fiscal 1996; $2,759,000 in fiscal 1995; and
$1,788,000 in fiscal 1994.
Selling and marketing expenses represented the largest decrease
in expenses from 1995 to 1996. Such expenses totaled $1,764,000
in the fiscal year ending June 30, 1996, as compared with
$2,547,000 in the preceding year and $951,000 in fiscal 1994. The
decrease in expenses from 1995 to 1996 reflected management's
decision in the fourth quarter of 1995 to terminate an aggressive
marketing plan for the Company's ICR products, which had begun in
the second quarter of fiscal 1995. That plan had entailed
increases in sales staff, promotional expenditures, and the
staffing of a customer-support group dedicated to ICR product
support.
Sales and marketing compensation, consisting of salaries, fringe
benefits, and commissions, totaled $999,000 in fiscal 1996, as
compared with $1,030,000 in the prior year and $431,000 in the
fiscal year ending June 1994. Related consulting decreased to
$69,000 in fiscal 1996 from $195,000 in 1995 and $31,000 in 1994.
Promotional expenses, comprising advertising, promotion, and
conventions and meetings, decreased $513,000 to $232,000 in
fiscal 1996 from $745,000 in the prior year. Such costs totaled
$226,000 in the fiscal year ended June 30, 1994.
General and administrative expenses totaled $828,000 in fiscal
1996, as compared with $843,000 in the preceding year and
$782,000 in fiscal 1994. As noted above, general and
administrative expenses in fiscal 1995 and 1994 reflect the
reclassification of $210,500 and $287,969, respectively, to
"Other income (expense)". These amounts represent non-cash
charges relating to the issuance of stock or exercise of warrants
at below-market prices.
Other Income (Expense)
In fiscal 1996, the Company recorded "Other income" of
approximately $40,000, net of "Other expense". Included in this
amount is a gain on the sale of intangibles of $213,000 relating
to the Asset Purchase Agreement with NCS signed in June 1996.
The Company recorded interest expense, net of interest income,
totaling $39,000. Additionally, the Company recorded a non-cash
expense of $131,000 relating to the reduction of exercise price
of outstanding warrants in connection with the Rights Offering
completed in the second fiscal quarter.
In the fiscal year ended June 30, 1995, the Company recorded
"Other expense" of $221,000. Non-cash charges relating to the
issuance of stock at below-market prices totaled $210,000, and
the Company recorded net interest expense of $11,000.
In fiscal 1994, "Other expense" totaled $282,000, reflecting
primarily non-cash charges relating to the exercise of warrants
at below-market prices, of $288,000.
Investment in Product Development and Marketing.
The largest investment made by the Company was in its Intelligent
Character Recognition group. During the fiscal year ended June
1996, product-development and marketing expenses exceeded
revenues (excluding the initial license fee paid by NCS) by
approximately $436,000. As noted above, on June 11, 1996,
National Computer Systems, Inc. signed a License Agreement which
transferred to them the right to develop and market these
products. NCS is required to pay minimum annual royalties to
maintain its exclusive license. The Company has since terminated
most of the costs associated with these products.
Expenses of the Company's generic products (the Ni1000
Recognition Accelerator and the Company's proprietary software-
development tools) exceeded revenues by approximately $212,000 in
fiscal 1996. In September 1995, the Company began work on a
contract with the Jet Propulsion Laboratory to develop a
prototype sensor system designed for vehicular-traffic
surveillance and detection.
Revenues relating to the Company's PRISM and Fraud Detection
System exceeded expenses by approximately $256,000 in fiscal
1996. The Company has license agreements with Mellon Bank, GE
Consumer Credit Financial Services, Bank One, Europay
International (an association of 700 banks in Europe), and with a
European financial-services company for the use of these
products.
Net Income Per Share
For the fiscal year ended June 1996, the Company experienced a gain of
$12,690 or $.00 per share, as compared with a loss of $3,457,422 or
$.47 per share in the prior year and a loss of $1,758,584 or $.26 per
share in fiscal 1994. For the fiscal year ended June 1996 there were
outstanding a weighted average of 7,847,510 shares, as compared with
7,411,502 in fiscal 1995 and 6,840,407 in fiscal 1994.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
the report to be signed on its behalf by the undersigned,
thereunto duly authorized.
NESTOR, INC.
(Registrant)
/s/David Fox
President and CEO
Date: September 26, 1996
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signatures Title Date
/s/Leon N Cooper Co-Chairman of the Board September 26, 1996
and
Director
/s/Charles Elbaum Co-Chairman of the Board September 26, 1996
and
Director
/s/David L. Fox President, Chief September 26, 1996
Executive Officer and
Director
/s/Herbert S. Meeker Secretary and Director September 26, 1996
/s/Sam Albert Director September 26, 1996
/s/Jeffrey Harvey Director September 26, 1996
/s/Thomas F. Hill Director September 26, 1996
/s/Bruce Schnitzer Director September 26, 1996
CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-K
JUNE 30, 1996
NESTOR, INC. Part II
Item 8
CONTENTS
Independent Auditor's Report
Statement No.
Consolidated Balance Sheets - June 30, 1996 and 1995 1
Consolidated Statements of Operations -
For the Years Ended June 30, 1996, 1995 and 1994 2
Consolidated Statements of Cash Flows -
For the Years Ended June 30, 1996, 1995 and 1994 3
Consolidated Statements of Stockholders' Equity -
For the Three Years Ended June 30, 1996 4
Notes to Consolidated Financial Statements
Part II
Item 8
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
of Nestor, Inc.
Providence, Rhode Island
We have audited the accompanying consolidated balance sheets of
Nestor, Inc. as of June 30, 1996 and 1995, and the related
consolidated statements of operations, cash flows, and
stockholders' equity for each of the three years in the period
ended June 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial
position of Nestor, Inc. as of June 30, 1996 and 1995 and the
results of its operations and its cash flows for each of the
three years in the period ended June 30, 1996, in conformity with
generally accepted accounting principles.
/s/ GASSMAN, REBHUN & CO., P.C.
New York, New York
September 6, 1996
NESTOR, INC.
Consolidated Balance Sheets
ASSETS June 30,1996 June 30, 1995
Current assets:
Cash and cash equivalents $ 2,013,317 $ 452,588
Accounts receivable, net of allowance for
doubtful accounts 594,310 661,734
Unbilled contract revenue 282,936 208,352
Other current assets 230,738 131,163
Total current assets 3,121,301 1,453,837
Property and equipment at cost - net of 219,787 347,325
depreciation
Other assets 10,783 11,333
Total Assets $ 3,351,871 $ 1,812,495
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Notes payable $ --- $ 1,700,000
Accounts payable and accrued expenses 768,411 1,381,457
Due to Sligos, S.A. 275,000 175,000
Deferred income 86,104 77,311
Other current liabilities 8,125 2,944
Total current liabilities 1,137,640 3,336,712
Noncurrent liabilities:
Long term obligations under capital leases 9,455 ---
Due to Sligos, S.A. --- 100,000
Total liabilities 1,147,095 3,436,712
Long term portion of deferred income 430,899 438,896
Redeemable Convertible Preferred Stock 5,207,538 1,600,328
(see below)
Commitments and contingencies --- ---
Stockholders' deficit:
Preferred stock, $1.00 par value,
authorized 10,000,000 shares; issued and
outstanding:
Series A - 452,064 shares at June 30, 1996
and 1995
(liquidation value $904,128 - $2.00 per 452,064 452,064
share)
Series B - 2,075,000 shares at June 30, 1996
(liquidation value $2,075,000 - $1.00 per
share)
and 2,540,000 shares at June 30, 1995
(liquidation value $2,540,000 - $1.00 per 2,075,000 2,540,000
share)
Series D - 184,671 shares at June 30, 1996
(liquidation value $277,007 - $1.50 per
share plus accrued dividends) and none at
June 30, 1995 277,007 ---
(liquidation value $1.50 per share plus
accrued dividends)
Series C, E, F, G and H redeemable
convertible preferred stock shown above:
4,846 shares at June 30, 1996 and 1,500
shares at June 30, 1995 (liquidation value --- ---
$1,000 per share plus accrued dividends)
Common stock, $.01 par value.
authorized 30,000,000 shares; issued and
outstanding:
8,280,941 shares at June 30, 1996 and 82,809 76,067
7,606,710 shares at June 30, 1995
Warrants and options 375,000 375,000
Additional paid-in capital 11,501,790 11,103,449
Retained (deficit) (18,197,331 (18,210,021)
Total stockholders' deficit (3,433,661) (3,663,441)
Total Liabilities and Stockholders' Deficit $ 3,351,871 $ 1,812,495
The notes to the financial statements are an
integral part of this statement
NESTOR, INC.
Consolidated Statements of Operations
For the Years Ended June 30
1996 1995 1994
Revenues:
Software licensing $ 2,825,600 $ 1,713,897 $ 1,349,470
Engineering services 2,378,135 1,195,201 641,579
Tangible product sales 257,845 286,465 239,425
Total revenue 5,461,580 3,195,563 2,230,474
Operating Expenses:
Software licensing 686,006 1,979,067 1,159,920
Engineering services 1,833,531 665,421 628,448
Tangible product sales 169,183 128,387 89,775
Selling and marketing 1,764,585 2,547,911 951,426
General and administrative 828,085 843,240 782,875
Related party consulting 207,450 267,935 94,196
and legal fee
Total operating expenses 5,488,840 6,431,961 3,706,640
Loss from operations (27,260) (3,236,398) (1,476,166)
Other income (expense) - net 39,950 (221,024) (282,418)
Income (loss) for the year 12,690 (3,457,422) (1,758,584)
before income taxes
Income taxes --- --- ---
Net Income (Loss) for the $ 12,690 $(3,457,422) $(1,758,584)
Year
Income (Loss) per Share $ --- $ (0.47) $ (0.26)
Weighted Average Number of 7,847,510 7,411,502 6,840,407
Shares Outstanding
The notes to the financial statements are an integral
part of this statement
<|TABLE>
NESTOR, INC.
Consolidated Statements of Cash Flows
For the Years Ended June 30
1996 1995 1994
Cash flows from operating
activities:
Net income (loss) $ 12,690 $ (3,457,422) $(1,758,584)
Adjustments to reconcile net
income (loss) to net
cash provided by operating
activities:
Depreciation & amortization 104,559 113,562 200,460
Loss on disposal of fixed assets 4,346 --- 106
Expenses charged to
operations relating to
options, warrants and 178,375 210,500 287,969
capital transactions
Changes in assets and
liabilities:
(Increase) decrease in 67,424 (340,651) (69,791)
accounts receivable
(Increase) decrease in
unbilled contract revenue (74,584) (87,674) (60,274)
(Increase) decrease in
other current assets (99,575) (110,721) (8,193)
(Increase) decrease in
other assets 500 (5,000) ---
(Decrease) increase in
accounts payable
and accrued expense (568,309) 786,010 144,294
(Decrease) increase in
deferred income 796 (15,630) 44,746
Net cash (used) by
operating activities (373,728) (2,907,026) (1,219,267)
Cash flows from investing
activities:
Purchase of property and
equipment (57,531) (249,319) (66,292)
Proceeds from the disposal of
fixed assets 85,000 --- 1,900
Net cash provided (used) by
investing activities 27,469 (249,319) (64,392)
Cash flows from financing
activities:
Repayment of obligations under
capital leases (7,924) (10,796) (5,998)
Proceeds from notes payable 300,000 1,700,000 ---
Rights offering expense (136,421) (39,769) ---
Proceeds from issuance of
common stock 99,510 73,288 625,125
Proceeds from issuance of
preferred stock - net 1,651,823 1,470,000 811,608
Net cash provided by
financing activities 1,906,988 3,192,723 1,430,735
Net change in cash and cash
equivalents 1,506,729 36,378 147,076
Cash and cash equivalents -
beginning of year 452,588 416,210 269,134
Cash and cash equivalents - $ 2,013,317 $ 452,588 $ 416,210
End of Year
Supplemental cash flows
information:
Interest paid $ 4,372 $ 3,728 $ 1,685
Income taxes paid $ --- $ --- $ ---
The notes to the financial statements are
an integral part of this statement
Nestor's Stockholders' Equity
Common Stock Preferred Stock Additional Retained Stock
Shares $ Amt. Shares $Amt. Paid-in (Deficit) Warrants Total
Capital
Balance at
June 30, 1993 6,802,710 68,027 2,407,064 2,407,064 10,033,105 (12,994,015) --- (485,819)
Issuance of
Capital Stock 332,625 3,326 815,000 815,000 906,367 --- --- 1,724,693
Conversion of
Preferred Stock
to Common Stock 95,000 950 (95,000) (95,000) 94,050 --- --- ---
(Loss) for the
year ended
June 30, 1994 --- --- --- --- --- (1,758,584) --- (1,758,584)
Balance at
June 30, 1994 7,230,335 72,303 3,127,064 3,127,064 11,033,522 (14,752,599) --- (519,710)
Issuance of
Capital Stock 141,375 1,414 --- --- 282,374 --- --- 283,788
Issuance of
Preferred Stock --- --- 100,000 100,000 100,000 --- --- 200,000
Cost of rights
offering --- --- --- --- (39,769) --- --- (39,769)
Conversion of
Preferred Stock
to Common Stock 235,000 2,350 (235,000) (235,000) 232,650 --- --- ---
Dividends
accrued
on Redeemable
Convertible
Preferred Stock
Series C --- --- --- --- (100,328) --- --- (100,328)
Reclassification
of Series C
Redeemable
Convertible
Preferred Stock
from capital --- --- --- --- (405,000) --- 375,000 (30,000)
(Loss) for the
year ended
June 30, 1995 --- --- --- --- --- (3,457,422) --- (3,457,422)
Balance at
June 30, 1995 7,606,710 76,067 2,992,064 2,992,064 11,103,449 (18,210,021) 375,000 (3,663,441)
Issuance of
Common Stock 177,998 1,780 --- --- 175,928 --- --- 177,708
Issuance of
Preferred Stock --- --- 210,549 315,824 (10,000) --- --- 305,824
Conversion of
Preferred Stock
to Common Stock 490,878 4,909 (490,878) (503,817) 498,908 --- --- ---
Dividends on
Preferred Stock
Series D paid in
Common Stock 5,355 53 --- --- 13,495 --- --- 13,548
Dividends
accrued on
Redeemable
Convertible
Preferred Stock --- --- --- --- (274,819) --- --- (274,819)
Expenses
incurred
in reduction of
Exercise Price
of Outstanding
Warrants --- --- --- --- 131,250 --- --- 131,250
Costs incurred
in connection
with August
1995 securities
registration --- --- --- --- (136,421) --- --- (136,421)
Income for the
year ended
June 30, 1996 --- --- --- --- --- 12,690 --- 12,690
Balance at
June 30, 1996 8,280,941 82,809 2,711,735 2,804,071 11,501,790 (18,197,331) 375,000 (3,433,661)
The notes to the financial statements are an integral part of this statement
Note 1 -Summary of significant accounting policies:
A. Organization
Nestor, Inc. was organized on March 21, 1983 in
Delaware to exploit, develop and succeed to certain patent
rights and know-how which the Company in 1983 acquired
from its predecessor, Nestor Associates, a limited
partnership. The Company's principal office is located in
Providence, RI.
The accompanying financial statements include the
accounts of Nestor, Inc. and Nestor Financial Services
Group, a joint venture (organized in December, 1986, and
dissolved effective December 31, 1995 - See Note 8). All
intercompany transactions and balances have been
eliminated.
B. Income taxes
Nestor, Inc. provides for income taxes on
transactions in the period they enter into the
determination of net income irrespective of when they are
recognized for income tax purposes. Where timing
differences result in taxable income being different from
that recorded in the accounts, the tax effect is shown as
"Deferred Income Tax" in the balance sheet.
C. Product and patent development costs
The costs of development of the Company's software
which consist primarily of labor and outside consulting
and which are an inherent cost of the Company's business
and costs of research and development are expensed until
technological feasibility has been established for the
product. Thereafter, all software production costs would
be capitalized and subsequently reported at the lower of
unamortized cost or net realizable value. At June 30,
1996, the Company had no capitalized software development
costs because the products developed were simultaneously
available for general release to customers when
technological feasibility was established. Capitalized
costs are amortized on a straight-line basis over the
estimated economic life (three to five years) of the
product.
Patent-development costs are similarly treated.
Their amortization would be on a straight-line basis over
the shorter of the estimated economic life, or statutory
life, of the patent.
D. Investment tax credits
Investment tax credits are accounted for on the "flow-
through" method as a reduction of the current provision
for federal income taxes.
E. Depreciation and amortization
Depreciable assets are recorded at cost.
Depreciation is provided for on the straight-line method
over the estimated useful lives of the respective assets.
Maintenance and repairs are expensed as incurred.
Major renewals and betterments are capitalized.
F. Revenue recognition
The Company recognizes revenue based upon the
following methods:
a) Revenue from software licensing/sales is
recognized upon shipment provided that no significant
vendor and post-contract support obligations remain
outstanding and collection of the resulting receivable
is deemed probable. Where there are insignificant post-
contract support obligations and/or warranties remaining
at the time of shipment, the Company recognizes revenue
and accrues the estimated cost of fulfilling such
obligations or warranties.
Product returns or exchanges are charged to operations
as incurred. Where the Company anticipates significant
returns of products sold, the Company establishes an
allowance for anticipated returns or exchanges at the
time of sale. When a product is sold subject to
customer approval, revenue is recognized upon approval
by the customer.
b) Engineering contract revenue from long-term
contracts is recognized on the percentage-of-completion
method, based upon the pattern of actual performance
under the agreement with the customer. Management
records expected losses on contracts in the period in
which such losses become foreseeable.
c) Training revenue is recognized upon the
completion of training sessions with the customer.
d) The Company recognizes revenue with respect to
customer-funded research and development as the expense
is incurred on the percentage-of-completion method.
G. Cash equivalents
For the purpose of the statement of cash flows, the
Company considers all highly liquid debt instruments
purchased with a maturity of 90 days or less to be cash
equivalents.
H. Foreign currency translation
Assets and liabilities of operations outside the
United States are translated into United States dollars
using current exchange rates; revenue and expense items
are translated into United States dollars using a weighted
average exchange rate for the period. The effects of
foreign currency translation adjustments are deferred
until realized and included as a component of
stockholders' equity.
I. Accounting for issuance and exercise of warrants and
options to purchase Common Stock
The Company records no expense upon the issuance of
warrants and options issued at fair market value. For
warr