**UNITED      STATES**

**SECURITIES      AND EXCHANGE COMMISSION**

**FORM          10-K/A**

**Amendment          No. 1**

| x                                             | ANNUAL                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE                ACT OF                1934    |
|-----------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                                          | For                the period ended                                                                                                   | December                31, 2006 |
|                                          | OR                                                                                                                                    |
| ¨                                        | TRANSITION                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE                ACT OF                1934 |
|                                          | For                the transition period from                                                                                         | _____________                to _____________ |
| Commission                file Number 0-12965 |

|                                                                       |
|----------------------------------------------------------------------------|
| (Exact                name of registrant as specified in its charter)      |
| DELAWARE                                                                   |   | 13-3163744 |
| (State                of incorporation)                                    |   | (I.R.S.                Employer Identification No.) |
|                                                                       |
| 42                Oriental Street; Providence, Rhode Island                | 02908 |
| (Address                of principal executive offices)                    | Zip                Code |
|                                                                       |   |
| (401)                274-5658                                              |
| (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) |

| Indicated                by check mark if the registrant is a well-known seasoned issuer,                as                defined in Rule 405 of the Securities Act.                                                                                                                                                                                                                                                                         | Yes: | ¨ | No: | x      |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------|--------|-----|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| Indicate                by check mark if the registrant is not required to file reports pursuant                to Section 13 or Section 15(d) of the Act.                                                                                                                                                                                                                                                                                    | Yes: | ¨ | No: | x      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 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.  ¨                                                                                                                                                                                                                                                                                                                                                                            |

|                                                                                                                                                                                                                                                                                                                                        |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Indicate                by check mark whether the Registrant is a large accelerated filer,                an                accelerated filer, or a non-accelerated filer. See definition of                “accelerated filer and large accelerated filer” in Rule 12b-2 of the                Exchange Act. (Check one): |

|   | Large                Accelerated filer: | ¨ |   | Accelerated                filer: | ¨ |  Non-accelerated                filer: | x |   |   |
|--------|-----------------------------------------|--------|--------|-----------------------------------|--------|---------------------------------------------|---|--------|--------|

|   |
|--------|

| Indicated                by check mark whether the registrant is a shell company: | Yes: | ¨ | No: | x |
|-----------------------------------------------------------------------------------|------|--------|-----|---|

|                                                                                                                                                                                                                                                                                               |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  The                aggregate market value of the 10,319,296 shares of voting stock held                by non-affiliates of the registrant on June 30, 2006, based on the                closing                price of such stock on June 30, 2006, was $33.3                million. |
|                                                                                                                                                                                                                                                                                               |

| The                number of shares outstanding of the Registrant’s Common Stock at                March 26, 2007 was                20,421,816 |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|

|                                                                                                                                                                                                                                    |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **DOCUMENTS                INCORPORATED BY REFERENCE**                                                                                                                                                                                  |
|                                                                                                                                                                                                                                    |
| Sections                of Nestor, Inc.’s definitive Proxy Statement for the 2007 Annual Meeting                of Stockholders are incorporated by reference into Parts II and III                of                this report. |

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**NESTOR,      INC.**

**ANNUAL      REPORT ON FORM 10-K**

**FOR      THE FISCAL YEAR ENDED DECEMBER 31, 2006**

**TABLE            OF CONTENTS**

|                                    |   |                                                                                                                                                     |   | **Page** |
|-----------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|
| **PART                    I**           |   |                                                                                                                                                     |   |     |
| Item                    1:              |   | Business                                                                                                                                                 |   |  3  |
| Item                    1A:             |   | Risk                    Factors                                                                                                                          |   |  14 |
| Item                    2:              |   | Properties                                                                                                                                               |   |  25 |
| Item                    3:              |   | Legal                    Proceedings                                                                                                                     |   |  25 |
| Item                    4:              |   | Submission                    of Matters to a Vote of Security Holders                                                                                   |   |  26 |
|                                    |   |                                                                                                                                                     |   |     |
| **PART                    II**          |   |                                                                                                                                                     |   |     |
| Item                    5:              |   | Market                    for Registrant’s Common Equity, Related Stockholder Matters and Issuer                    Purchases of Equity Securities |   |  27 |
| Item                    6:              |   | Selected                    Financial Data                                                                                                               |   | 29       |
| Item                    7:              |   | Management’s                    Discussion and Analysis of Financial Condition and Results of                    Operations                        |   |  31 |
| Item                    7A:             |   | Quantitative                    and Qualitative Disclosures about Market Risk                                                                            |   |  44 |
| Item                    8:              |   | Financial                    Statement and Supplementary Data                                                                                            |   |  45 |
| Item                    9:              |   | Changes                    in and Disagreements with Accountants on Accounting and Financial                    Disclosure                               |   | 82       |
| Item                    9A:             |   | Controls                    and Procedures                                                                                                               |   |  82 |
| Item                    9B:             |   | Other                    Information                                                                                                                     |   | 82       |
|                                    |   |                                                                                                                                                     |   |     |
| **Part                    III**         |   |                                                                                                                                                     |   |     |
| Item                    10:             |   | Directors,                    Executive Officers and Corporate Governance                                                                                |   | 82       |
| Item                    11:             |   | Executive                    Compensation                                                                                                                |   | 83       |
| Item                    12:             |   | Security                    Ownership of Certain Beneficial Owners and Management and Related                    Stockholder Matters                     |   |  83 |
| Item                    13:             |   | Certain                    Relationships, Related Transactions and Director                    Independence                                              |   |  83 |
| Item                    14:             |   | Principal                    Accountant Fees and Services                                                                                                |   | 83       |
|                                    |   |                                                                                                                                                     |   |     |
| **Part                    IV**          |   |                                                                                                                                                     |   |     |
| Item                    15:             |   | Exhibits                    and Financial Statement Schedules                                                                                            |   |  84 |
|  Item                    15(a)(2): |   |  Consolidated                  Financial Statement Schedule -- December 31, 2006, 2005, 2004                                                        |   |  85 |
|                                    |   |                                                                                                                                                     |   |     |
|                                    |   |                                                                                                                                                     |   |     |
|                                    |   |  Signatures                                                                                                                                         |   |  86 |
|                                    |   |  Index                  of Exhibits                                                                                                                 |   |  87 |
|                                    |   |                                                                                                                                                     |   |     |

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**PART      I**

**Restatement      of Consolidated Financial Statements**

**General**

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**Our      **
**Market**

***Status      of the CrossingGuard Market***

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| ArizonaCaliforniaColoradoDelawareFloridaGeorgiaIllinoisIowa | Louisiana                MarylandMassachusettsMissouriNew                MexicoNew                YorkNorth                CarolinaOhio | Oregon                PennsylvaniaRhode                IslandSouth                DakotaTennesseeTexasWashingtonWashington,                D.C. |
|-------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|

| Alberta                         |
|---------------------------------|
| British                Columbia |
| Manitoba                        |
| Ontario                         |
| Saskatchewan                    |

***Status      of the Speed Market***

| *UNITED                STATES* |                          | *CANADA*                       |
|--------------------------------|-------------------------------|--------------------------------|
| Arizona                        | New                Mexico     | Tennessee                      |   | Alberta |
| California                     | North                Carolina | Washington                     |   | Manitoba |
| Colorado                       | Ohio                          | Washington,                D.C |   |   |
| Iowa                           | Oregon                        |                           |   |   |

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***Our      Response to the Market***

**Company      History**

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**Products      and Services**

***CrossingGuard      Red Light Enforcement***

*CrossingGuard.*

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*Accurate,      real-time interpretation of traffic video images.*

*Vehicle      trajectory analysis for real-time forecasting.*

*Compatibility      with industry standard platforms.*

*CrossingGuard      VIP.*

*Revenue      Generation*

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** **

***Poliscan***
***speed***

***Products***

*Poliscan      Speed. *

| · | High                resolution all digital camera                solution |
|--------|---------------------------------------------------------------------------|

| · | All                weather, day and night operations with no visible                illumination |
|--------|--------------------------------------------------------------------------------------------------|

| · | 100                scans per second in the 45 degree scan                sector |
|--------|---------------------------------------------------------------------------------|

| · | Multi-lane,                multi-vehicle, bi-directional speed                enforcement |
|--------|-------------------------------------------------------------------------------------------|

| · | Not                restricted to straight roads (only needs 20 meters to                operate) |
|--------|--------------------------------------------------------------------------------------------------|

| · | 3D                image processing (Scans entire road, all                lanes) |
|--------|----------------------------------------------------------------------------------|

| · | Fully                automated, unattended operations |
|--------|-------------------------------------------------------|

*Deployment      and Set Up. *

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*Revenue      Generation. *

***Products***

* *

* *

*™      *

*Deployment      and Set Up. *

***Program      Management and Processing Services***
** **

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*Rail      CrossingGuard.*

*TrafficVision.*

**Sales,      Marketing and Methods of Distribution **

** **

**Research      and Development Activities **

| · | Our                "All Digital" CrossingGuard system, which enhances image quality (up                to 12.4 megabytes), efficiency and reliability while reducing installation                costs and supporting infrastructure needs.  The All Digital system                uses decentralized processing and provides a completely digital Ethernet                solution.  With internet protocol addressable cameras, it can provide                live video for homeland security or other applications; |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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| · | Our                CrossingGuard Speed system, which can utilize any of three speed                detection                systems - Ka band radar, single beam traditional LiDAR and Vitronic’s                scanning LiDAR. The integration of all known types of non-intrusive                speed                sensors into our product allows us to deliver a full array of solutions                to                the customer while maintaining the advantage of full motion digital                video;                and, |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | ViDAR™                utilizing distance over time calculations in combination with video                detection and tracking technology to measure and record the scene,                license                plate and driver images from speeding                vehicles. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Patents**

**Competition**

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** **

**Contracts      with Governmental Entities**

**Employees**

** **
** **
** **

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| ITEM                1A. | Risk                Factors |
|-------------------------|-----------------------------|

**Risks      Related to Our Business**

***We      have a history of losses and expect to incur losses in the future.***

***We      have substantial indebtedness.***

| · | requiring                  us to dedicate a substantial portion of the net proceeds of the                  debt and                  any cash flow from operations to the payment of interest, and potentially                  principal, on our indebtedness, thereby reducing the availability                  of such                  proceeds and cash flow to fund working capital, capital expenditures                  or                  other general corporate purposes. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | increasing                  our vulnerability to general adverse economic and industry                  conditions, |
|--------|---------------------------------------------------------------------------------------------------------------------|

| · | limiting                  our ability to obtain additional financing to fund future working                  capital,                  capital expenditures, research and development and other general                  corporate                  requirements; |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | limiting                  our flexibility in planning for, or reacting to, changes in our                  business                  and the industry; and |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | placing                  us at a disadvantage compared to our competitors with less debt                  and                  competitors that have better access to capital                  resources. |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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***Our      debt service costs exceed our current operating cash      flow.***

***If      our financial performance doesn’t improve, our interest costs will      increase.***

*Share-Based      Payment*

***We      have granted a lien on substantially all of our assets.***

***We      will need additional financing, which may be difficult or impossible to obtain      and may restrict our operations and dilute stockholder ownership      interest.***

*We      have substantial indebtedness*

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***Substantially      all of our current revenue is from a single product and related services.***

***We      have limited experience in the speed enforcement market.***

***We      may not maintain our rights to market Poliscan.***

***A      substantial portion of our debt is subject to redemption at the holder’s option      prior to maturity.***

*Share-Based      Payment*

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***Our      financial condition and results of operations may be adversely affected if      we      are unable to secure and maintain future contracts with government      entities.***

***We      face substantial competition and may not be able to compete      successfully.***

***The      failure of governments to authorize or maintain automated traffic enforcement      may hinder our growth and harm our business.***

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***Our      products might not achieve market acceptance, which could adversely affect      our      growth.***

| · | The                failure of states to adopt or maintain legislation enabling the use                of                automated traffic enforcement                systems; |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                failure of prospective customers to conclude that our products are                valuable and should be used; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------|

| · | The                reluctance of our prospective customers to replace their existing                solutions with our products; |
|--------|----------------------------------------------------------------------------------------------------------------------------------|

| · | Marketing                efforts of our competitors; and |
|--------|----------------------------------------------------------|

| · | The                emergence of new technologies that could cause our products to be                less                competitive or obsolete. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|

***Our      speed products are not certified by the International Association of Chiefs      of      Police.***

***Earnings      for future periods may be affected by impairment charges.***

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***Concerns      about privacy rights and negative publicity regarding our industry could slow      acceptance of our products.***

***Concentration      of our processing operations in one location exposes us to potential business      interruption in the event of a natural disaster.***

***Our      financial results will depend significantly on our ability to continually      develop our products and technologies.***

| · | Proper                product definition; |
|--------|-------------------------------------------|

| · | Timely                completion and introduction of enhanced product designs; |
|--------|--------------------------------------------------------------------------------|

| · | The                ability of subcontractors and component manufacturers to effectively                design and implement the manufacture of new or enhanced products                and                technologies; |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                quality of our products and technologies; |
|--------|--------------------------------------------------------------|

| · | Product                and technology performance as compared to competitors' products and                technologies; |
|--------|-------------------------------------------------------------------------------------------------------------------------|

| · | Market                acceptance of our products; and |
|--------|-------------------------------------------------------|

| · | Competitive                pricing of products, services and                technologies. |
|--------|-------------------------------------------------------------------------------------------|

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***Fluctuations      in our results of operations make it difficult to predict our future performance      and may result in volatility in the market price of our common      stock.***

| · | Costs                  related to customization of our products and services; |
|--------|-------------------------------------------------------------------------------|

| · | Announcements                or introductions of new products and services by our                competitors; |
|--------|---------------------------------------------------------------------------------------------------------------|

| · | The                failure of additional states to adopt or maintain legislation enabling                the                use of automated traffic enforcement systems; |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Determinations                by state and local government bodies to utilize our equipment without                the                additional processing services we                provide; |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Software                defects and other product quality                problems; |
|--------|------------------------------------------------------------------------------------|

| · | A                shift towards fixed rate, as opposed to per ticket, compensation                arrangements for our speed products, which could adversely affect                revenues; |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Adjustments                in the estimates used to report revenue under contracts that require                payment only after our customer has collected the fine; |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                discretionary nature of our customers’ internal evaluation, approval and                order processes; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------|

| · | The                varying size, timing and contractual terms of orders for our products                and                services; and |
|--------|------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                mix of revenue from our products and                services. |
|--------|----------------------------------------------------------------------------------|

***Our      sales cycles vary significantly, making it difficult to plan our expenses and      forecast our results.***

| · | The                complex nature of our products and                services; |
|--------|--------------------------------------------------------------------------------|

| · | Political                  or legal challenges to legislation authorizing the use of automated                  traffic enforcement systems; |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                  novelty of automated traffic enforcement in many jurisdictions                  and a lack                  of familiarity with automated traffic enforcement systems on the                  part of                  legislative, executive and judicial bodies and the                  public; |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                selection, award and contracting processes at municipalities and                other                government entities, including protests by other bidders with respect                to                competitive awards; |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Our                customers’ internal evaluation, approval and order                processes; |
|--------|-------------------------------------------------------------------------------------------------------|

| · | The                site evaluation and analysis process; and |
|--------|--------------------------------------------------------------|

| · | Our                customers' delays in issuing requests for proposals or in awarding                contracts because of announcements or planned introductions of new                products or services by our                competitors. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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***Our      intellectual property might not be protectible, and if we fail to protect and      preserve our intellectual property, we may lose an important competitive      advantage.***

***We      are at risk of claims that our products or services infringe the proprietary      rights of others.***

***If      we are unable to safeguard the integrity, security and privacy of our data      or      our customers' data, our revenue may decline, our business could be disrupted      and we may be sued.***

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***We      may be subject to product liability claims that could result in costly and      time-consuming litigation.***

***The      failure of our suppliers to deliver components, equipment and materials in      sufficient quantities and in a timely manner could adversely affect our      business.***

***If      we lose our key personnel or are unable to attract and retain additional      personnel, our operations could be disrupted and our business could be      harmed.***

***We      may make acquisitions, which could divert management’s attention, cause      ownership dilution to our stockholders and be difficult to      integrate.***

| · | Acquired                  businesses may not achieve anticipated revenues, earnings or cash                  flow; |
|--------|--------------------------------------------------------------------------------------------------------------------|

| · | Integration                  of acquired businesses and technologies may not be successful and                  we may                  not realize anticipated economic, operational and other benefits                  in a                  timely manner, particularly if we acquire a business in a market                  in which                  we have limited or no current expertise or with a corporate culture                  different from ours; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Potential                  dilutive effect on our stockholders from the issuance of common                  stock as                  consideration for acquisitions; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Adverse                  effect on net income from impairment charges related to goodwill                  and other                  intangible assets, and other acquisition-related charges, costs                  and                  expenses effects on net income; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Competing                  with other companies, many of which have greater financial and                  other                  resources, to acquire attractive companies, making it more difficult                  to                  acquire suitable companies on acceptable terms or at all;                  and |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Disruption                  of our existing business, distraction of management, diversion                  of other                  resources and difficulty in maintaining our current business standards,                  controls and procedures. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**Risks      Related to Our Common Stock**

***Our      common stock price is volatile and may decline in the future.***

***Our      board of directors can, without stockholder approval, cause preferred stock      to      be issued on terms that could adversely affect common      stockholders.***

***Our      President and Chief Executive Officer beneficially owns a significant amount      of      our common stock and, accordingly, exercises significant control over our      business and affairs, including the approval of change in control transactions.***

***Provisions        of our secured notes and secured note warrants could delay or prevent a change        of control***

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***We      have not paid, and do not intend to pay, dividends and therefore, unless our      common stock appreciates in value, our investors may not benefit from holding      our common stock.***

***We      have a significant number of options, warrants and convertible securities      outstanding, which if exercised or converted, will have a dilutive effect upon      our stockholders. The anti-dilution provisions of some of these securities      could      magnify that dilutive effect..***

***The      price of our common stock may decline because a substantial amount of our common      stock is available for trading in the public market.***

** **
** **

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**PART      II**

|   |  Year                Ended December 31, 2006 |  Low |  High |
|--------|---------------------------------------------------|-----------|------------|
|   |                                              |      |       |
|   | 1st                Quarter                        | $2.80     | $6.00      |
|   | 2nd                Quarter                        | $2.80     | $3.80      |
|   | 3rd                Quarter                        | $2.30     | $3.38      |
|   | 4th                Quarter                        | $1.10     | $2.89      |

|   |  Year                  Ended December 31, 2005 |  Low |  High |
|--------|-----------------------------------------------------|-----------|------------|
|   |                                                |      |       |
|   | 1st                  Quarter                        | $4.50     | $7.43      |
|   | 2nd                  Quarter                        | $5.05     | $7.00      |
|   | 3rd                  Quarter                        | $4.40     | $6.75      |
|   | 4th                  Quarter                        | $4.80     | $9.17      |

*Holders      of Common Stock*

*Dividend      Policy*

*Securities        Authorized for Issuance Under Equity Compensation Plans*

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*Performance          Graph*

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|                                          |   |  Years                Ended December 31,                               |
|-----------------------------------------------|--------|-----------------------------------------------------------------------------|
|                                          |   |  (In                Thousands, Except Share and Per Share Information) |
|                                          |   |                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |   |                                                                        |   |   |   |   |   |   | (As                Restated) |   |   | (As                Restated) |   |   |   |   |
|                                          |   |                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                          |   |                                                                        | 2006 |   |   | 2005 |   |   | 2004 |   |   | 2003 |   |   | 2002 |   |
| Revenue                                       |   | $                                                                           | 8,087 |   | $ | 7,769 |   | $ | 6,035 |   | $ | 2,706 |   | $ | 2,122 |   |
| Operating                loss                 |   |                                                                        | (13,902 | ) |   | (9,277 | ) |   | (4,647 | ) |   | (4,261 | ) |   | (15,127 | ) |
| Modified                EBITDA                |   |                                                                        | (6,055 | ) |   | (6,879 | ) |   | (2,102 | ) |   | (3,249 | ) |   | (2,419 | ) |
| Net                loss                       |   | $                                                                           | (7,491 | ) | $ | (6,764 | ) | $ | (6,178 | ) | $ | (5,325 | ) | $ | (12,634 | ) |
|                                          |   |                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss                per share:                |   |                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted                number of outstanding |   |                                                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| shares                - basic and diluted     |   |                                                                        | 20,277,770 |   |   | 18,826,966 |   |   | 18,223,609 |   |   | 12,964,498 |   |   | 5,047,611 |   |
| Loss                per share                 |   | $                                                                           | (0.37 | ) | $ | (0.36 | ) | $ | (0.34 | ) | $ | (0.41 | ) | $ | (2.50 | ) |

| Cash                and marketable securities |   | $      | 3,010  |   | $      | 1,280  |   | $      | 6,422  |   | $      | 5,410  |   | $      | 309    |   |
|-----------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Capitalized                systems investment |   |   | 6,270  |   |   | 3,562  |   |   | 1,829  |   |   | 2,341  |   |   | 1,017  |   |
| Total                assets                   |   | $      | 24,511 |   | $      | 19,215 |   | $      | 18,847 |   | $      | 16,299 |   | $      | 9,201  |   |
| Working                capital (deficit)      |   | $      | 3,433  |   | $      | (2,097 | )      | $      | 6,786  |   | $      | 3,294  |   | $      | (1,572 | )      |
| Long-term                liabilities          |   | $      | 14,942 |   | $      | 6,420  |   | $      | 7,812  |   | $      | 3,322  |   | $      | 2,849  |   |

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|   | **•** | increasing                or decreasing trends in modified EBITDA;                                 |
|--------|-------------|----------------------------------------------------------------------------------------------------|
|   |
|   | **•** | how                modified EBITDA compares to levels of debt and interest                expense. |

|                                                                  |   | ** Twelve                Months Ended December 31,** |           |
|-----------------------------------------------------------------------|--------|-----------------------------------------------------------|----------------|
|                                                                  |   |                                                      | **2006**  |   |   | **2005**  |   |   | **2004**  |   |
|                                                                  |   |                                                      |           |   |   |   |   |   |   |   |
| GAAP                net income (loss)                                 |   | $                                                         | (7,491         | ) | $ | (6,764 | ) | $ | (6,178 | ) |
| Interest                and financing expense, net of interest income |   |                                                      | 1,865          |   |   | 1,213 |   |   | 334 |   |
| Income                tax expense                                     |   |                                                      | ---            |   |   | --- |   |   | --- |   |
| Depreciation                and amortization                          |   |                                                      | 2,975          |   |   | 2,398 |   |   | 2,037 |   |
| EBITDA                                                                |   | $                                                         | (2,651         | ) | $ | (3,153 | ) | $ | (3,807 | ) |
| Derivative                instrument (income) expense                 |   |                                                      | (16,940        | ) |   | (7,780 | ) |   | 1,341 |   |
| Debt                discount expense                                  |   |                                                      | 8,664          |   |   | 4,054 |   |   | 364 |   |
| Stock-based                compensation expense                       |   |                                                      | 2,506          |   |   | --- |   |   | --- |   |
| Asset                impairment charge                                |   |                                                      | 2,366          |   |   | --- |   |   | --- |   |
| Modified                EBITDA                                        |   | $                                                         | (6,055         | ) | $ | (6,879 | ) | $ | (2,102 | ) |

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**Actual      results may differ from those indicated by such forward-looking statements      as a      result of various important factors, including, without limitation, those      factors discussed in this annual report under the heading “Risk      Factors.”**

**Executive      Summary**

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|                                                              |   | December                    31, |
|-------------------------------------------------------------------|--------|---------------------------------|
|                                                              |   |                            | 2006 |   |   | 2005 |   |   | 2004 |   |
| Number                    of Approaches and Units:                |   |                            |   |   |   |   |   |   |   |   |
|                                                              |   |                            |   |   |   |   |   |   |   |   |
| Installed,                    operational and revenue-generating: |   |                            |   |   |   |   |   |   |   |   |
| CrossingGuard                    red light approaches             |   |                            | 212 |   |   | 171 |   |   | 111 |   |
| Poliscanspeed                    Units                            |   |                            | 11 |   |   | 4 |   |   | 0 |   |
| Additional                    Authorized Approaches:              |   |                            |   |   |   |   |   |   |   |   |
| CrossingGuard                    red light approaches             |   |                            | 245 |   |   | 172 |   |   | 128 |   |
| Poliscanspeed                    Units                            |   |                            | 13 |   |   | 5 |   |   | 0 |   |
|                                                              |   |                            |   |   |   |   |   |   |   |   |
| Total                                                             |   |                            | 481 |   |   | 352 |   |   | 239 |   |

** **
** **

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**Critical      Accounting Policies and Estimates **

***Revenue      Recognition***

| a. | We                provide hardware and equipment, and related third party embedded                software                (“roadside systems”). The third party embedded software is considered                incidental to the system as a whole. In these arrangements, we typically                sell or lease the system as a stand alone roadside system and account                for                it either as a direct sale, in one instance as a sales type lease,                as it                met the criteria of a sales type lease in Financial Accounting Standards                Board (FASB) Statement of Financial Accounting Standards (FAS) No.                13 -                Accounting for Leases, or in most other cases as an operating lease                accounted for on a monthly basis. For each arrangement, usually upon                delivery for the sales type lease or monthly for operating type leases,                revenue is recognized as there exists evidence that an arrangement                exists,                the system is delivered, the price is fixed or determinable, and                collectability is reasonably assured in accordance with SAB 104; |
|----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| b. | We                provide services, which typically include citation processing, back                office                and hosting services. Software is more than incidental to the services                as                a whole, but 1) is used by us to capture and internally process the                violations and 2) customers do not have the right to and do not take                possession of our detection and tracking, or our citation processing                and                back office software. For these services, we typically recognize                revenue                on a fixed monthly fee or a per citation fee basis. Revenue usually                commences for these service arrangements, upon the first month after                inception of operations, as there exists evidence that an arrangement                exists, services have been rendered or delivered (citations and other                services are delivered), the price is fixed or determinable, and                collectability is reasonably assured;                and |
|----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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| c. | For                two current customers who want to process their own citations, we                lease                them our detection and tracking and citation processing and back                office                software and provide monthly customer support on the software. For                this                arrangement, we recognize revenue in accordance with Statement of                Position                97 -2 Software Revenue Recognition. Although all software deliverables                are                complete in the initial month of operations, and the monthly customer                support is the only undelivered element, we recognize revenue on                a monthly                basis as the citations are issued or                paid. |
|----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

***Unbilled      contract revenue***

***Allowance      for Doubtful Accounts***

***Inventory      Obsolescence***

***Capitalization      of Internal Buildout Costs***

***Share-Based      Compensation***

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***Derivative      Instruments***

***Long-Term      Asset Impairment***

***Deferred      Taxes***

***Concentrations      of credit risk***

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**Liquidity      and Capital Resources**

***Cash      Position and Working Capital***

** **

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***Commitments,      Contractual Obligations and Off-Balance Sheet      Arrangements***

| **Payments                due in:** |   |   | **Operating                Leases****(1)** |   |   | **5                % Senior Convertible Notes** |   |   | **7                % Senior Secured****Convertible                Notes** |   |   | **Debt                Interest** |   |   | **Total**  |   |
|-------------------------------------|--------|--------|--------------------------------------------|--------|--------|-------------------------------------------------|--------|--------|---------------------------------------------------------------------------|--------|--------|----------------------------------|--------|--------|------------|--------|
| **2007**                            |   |   | 398,000                                    |   |   | **---**                                         |   |   | **---**                                                                   |   |   | 1,741,000                        |   |   | 2,139,000  |   |
| **2008**                            |   |   | 367,000                                    |   |   | **---**                                         |   |   | **---**                                                                   |   |   | 1,741,000                        |   |   | 2,108,000  |   |
| **2009**                            |   |   | 367,000                                    |   |   | 2,850,000                                       |   |   | **---**                                                                   |   |   | 1,647,000                        |   |   | 4,864,000  |   |
| **2010**                            |   |   | 320,000                                    |   |   | **---**                                         |   |   | **---**                                                                   |   |   | 1,599,000                        |   |   | 1,919,000  |   |
| **2011**                            |   |   | 113,000                                    |   |   |                                            |   |   | 22,840,000                                                                |   |   | 640,000                          |   |   | 23,593,000 |   |
| **Thereafter**                      |   |   | ---                                        |   |   | **---**                                         |   |   | ---                                                                       |   |   | ---                              |   |   | ---        |   |
|                                |   | $      | 1,565,000                                  |   | $      | 2,850,000                                       |   | $      | 22,840,000                                                                |   | $      | 7,368,000                        |   | $      | 34,623,000 |   |

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**Results      of Operations**

|                                                            |   |  Fiscal                Year Ended December 31, |
|-----------------------------------------------------------------|--------|-----------------------------------------------------|
|                                                            |   |   2006                                    |   |   | %   |   |   |   2005 |   |   | %   |   |   |  2004 |   |   | %   |
|                                                            |   |                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |  (Restated)  |   |   |   |   |
| Lease                & Service Fees                         |   | $                                                   | 8,079,000 |   |   | 100 | % |   |   | $ | 5,975,000 |   |   | 77 | % |   |   | $ | 5,118,000 |   |   | 85 | % |
| Sales                & Royalty Revenue                      |   |                                                | 8,000 |   |   | --- |   |   |   |   | 1,794,000 |   |   | 23 | % |   |   |   | 917,000 |   |   | 15 | % |
| Total                Revenue                                    |   |                                                | 8,087,000 |   |   | 100 | % |   |   |   | 7,769,000 |   |   | 100 | % |   |   |   | 6,035,000 |   |   | 100 | % |
| Cost                of sales                                    |   |                                                | 6,313,000 |   |   | 78 | % |   |   |   | 5,732,000 |   |   | 74 | % |   |   |   | 3,932,000 |   |   | 65 | % |
| Gross                profit                                     |   |                                                | 1,774,000 |   |   | 22 | % |   |   |   | 2,037,000 |   |   | 26 | % |   |   |   | 2,103,000 |   |   | 35 | % |
| Operating                expenses, excluding impairment charges |   |                                                | 13,310,000 |   |   | 165 | % |   |   |   | 11,314,000 |   |   | 146 | % |   |   |   | 6,750,000 |   |   | 112 | % |
| Impairment                charge for long lived assets          |   |                                                | 2,366,000 |   |   | 29 | % |   |   |   | --- |   |   | --- |   |   |   |   | --- |   |   | --- |   |
| Loss                from operations                             |   |                                                | (13,902,000 | ) |   | 172 | % |   |   |   | (9,277,000 | ) |   | 114 | % |   |   |   | (4,647,000 | ) |   | 77 | % |
| (Loss)                gain on debt                              |   |                                                | --- |   |   | --- |   |   |   |   | (509,000 | ) |   | 7 | % |   |   |   | 508,000 |   |   | 8 | % |
| Other                income (expense)                           |   |                                                | (1,865,000 | ) |   | 23 | % |   |   |   | (704,000 | ) |   | 9 | % |   |   |   | (334,000 | ) |   | 6 | % |
| Derivative                instrument expense                    |   |                                                | 16,940,000 |   |   | 209 | % |   |   |   | 7,780,000 |   |   | 100 | % |   |   |   | (1,341,000 | ) |   | 22 | % |
| Debt                discount expense                            |   |                                                | (8,664,000 | ) |   | 107 | % |   |   |   | (4,054,000 | ) |   | 52 | % |   |   |   | (364,000 | ) |   | 6 | % |
| Net                loss                                         |   | $                                                   | (7,491,000 | ) |   | 93 | % |   |   | $ | (6,764,000 | ) |   | 87 | % |   |   | $ | (6,178,000 | ) |   | 102 | % |

***Analysis      of the Years Ended December 31, 2006 and December 31,      2005***

*Revenue*

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*Cost      of Sales*

*Gross      Profit*

*Operating      Expenses*

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*Derivative      instrument income (expense)*

*Debt      discount expense*

*Loss      on Debt Refinancing*

*Other      Expense - Net*

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*Net      Loss*

***Analysis      of the Years Ended December 31, 2005 and December 31,      2004***

*Revenue*

*Cost      of Sales*

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*Gross      Profit*

*Operating      Expenses*

*Gain      on Debt Extinguishment*

*Loss      on Debt Refinancing*

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*Other      Expense - Net*

*Derivative      instrument income (expense)*

*Debt      discount expense*

*Net      Loss*

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*Interest      Rates*

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**CONSOLIDATED      FINANCIAL STATEMENTS**

**December      31, 2006**

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**NESTOR,      INC.**

**CONTENTS**

|                  |   |                                                                                             | **Page                Number** |
|-----------------------|--------|--------------------------------------------------------------------------------------------------|--------------------------------|
|                  |   |                                                                                             |                           |
|                  |   | Report                of Independent Registered Public Accounting Firm                           | 47                             |
|                  |   |                                                                                             |                           |
| Item                1 |   | **Financial                Statements:**                                                         |                           |
|                  |   |                                                                                             |                           |
|                  |   | Consolidated                Balance Sheets                                                       |  48                       |
|                  |   | December                31, 2006 and 2005                                                        |                           |
|                  |   |                                                                                             |                           |
|                  |   | Consolidated                Statements of Operations                                             | 49                             |
|                  |   | For                the Years Ended December 31, 2006, 2005, 2004 (as                restated)    |                           |
|                  |   |                                                                                             |                           |
|                  |   | Consolidated                Statements of Stockholders’ Equity                             |  50                       |
|                  |   | For                the Years Ended December 31, 2006, 2005, 2004 (as                restated)    |                           |
|                  |   |                                                                                             |                           |
|                  |   | Consolidated                Statements of Cash Flows (Unaudited)                                 |  51                       |
|                  |   | For                the Years ended December 31, 2006, 2005 and 2004 (as                restated) |                           |
|                  |   |                                                                                             |                           |
|                  |   | Notes                to Condensed Consolidated Financial Statements                              |  52                       |
|                  |   |                                                                                             |                           |

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**Report      of Independent Registered Public Accounting Firm**

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**NESTOR,      INC.**

**Consolidated      Balance Sheets**

|                                                                                                                                                    |   |  **December              31, 2006**  |    |  **December              31, 2005** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|---------|------------------------------------------|--------|
|  (Unaudited)                                                                                                                                  |   |                                           |    |                                     |   |   |   |
| **ASSETS**                                                                                                                                              |   |                                           |    |                                     |   |   |   |
| **Current                Assets**                                                                                                                       |   |                                           |    |                                     |   |   |   |
| Cash                and cash equivalents                                                                                                                |   | $                                              | 2,952   |                                     | $      | 1,224 |   |
| Marketable                securities                                                                                                                    |   |                                           | 58      |                                     |   | 56 |   |
| Accounts                receivable, net                                                                                                                 |   |                                           | 2,343   |                                     |   | 1,949 |   |
| Inventory,                net                                                                                                                           |   |                                           | 1,950   |                                     |   | 1,671 |   |
| Other                current assets                                                                                                                     |   |                                           | 197     |                                     |   | 391 |   |
| Total                current assets                                                                                                                     |   |                                           | 7,500   |                                     |   | 5,291 |   |
| **Noncurrent                assets**                                                                                                                    |   |                                           |    |                                     |   |   |   |
| Capitalized                system costs, net                                                                                                            |   |                                           | 8,185   |                                     |   | 5,379 |   |
| Property                and equipment, net                                                                                                              |   |                                           | 789     |                                     |   | 925 |   |
| Goodwill                                                                                                                                                |   |                                           | 5,581   |                                     |   | 5,581 |   |
| Patent                development costs, net                                                                                                            |   |                                           | 125     |                                     |   | 146 |   |
| Other                long term assets                                                                                                                   |   |                                           | 2,331   |                                     |   | 1,893 |   |
| **Total                Assets**                                                                                                                         |   | $                                              | 24,511  |                                     | $      | 19,215 |   |
|                                                                                                                                                    |   |                                           |    |                                     |   |   |   |
| **LIABILITIES                AND STOCKHOLDERS’ EQUITY**                                                                                           |   |                                           |    |                                     |   |   |   |
| **Current                liabilities**                                                                                                                  |   |                                           |    |                                     |   |   |   |
| Current                portion of notes payable                                                                                                         |   | $                                              | ---     |                                     | $      | 4,136 |   |
| Accounts                payable                                                                                                                         |   |                                           | 1,325   |                                     |   | 1,071 |   |
| Accrued                liabilities                                                                                                                      |   |                                           | 1,493   |                                     |   | 1,471 |   |
| Accrued                employee compensation                                                                                                            |   |                                           | 351     |                                     |   | 478 |   |
| Deferred                revenue                                                                                                                         |   |                                           | 712     |                                     |   | 103 |   |
| Asset                retirement obligation                                                                                                              |   |                                           | 186     |                                     |   | 129 |   |
| Total                current liabilities                                                                                                                |   |                                           | 4,067   |                                     |   | 7,388 |   |
| **Noncurrent                Liabilities:**                                                                                                              |   |                                           |    |                                     |   |   |   |
| Long                term convertible notes payable                                                                                                      |   |                                           | 920     |                                     |   | 1,650 |   |
| Long                term notes payable                                                                                                                  |   |                                           | 8,563   |                                     |   | 3,286 |   |
| Derivative                financial instruments - debt and warrants                                                                                     |   |                                           | 4,971   |                                     |   | 1,419 |   |
| Long                term asset retirement obligation                                                                                                    |   |                                           | 488     |                                     |   | 65 |   |
| Total                liabilities                                                                                                                        |   |                                           | 19,009  |                                     |   | 13,808 |   |
|                                                                                                                                                    |   |                                           |    |                                     |   |   |   |
| Commitments                and contingencies                                                                                                            |   |                                           | ---     |                                     |   | --- |   |
|                                                                                                                                                    |   |                                           |    |                                     |   |   |   |
| **Stockholders’                Equity:**                                                                                                          |   |                                           |    |                                     |   |   |   |
| Preferred                stock, $1.00 par value, authorized 10,000 shares; issued                and outstanding: Series B - 180,000 shares at          |   |                                           |    |                                     |   |   |   |
| December                31, 2006                and December 31, 2005                                                                                   |   |                                           | 180     |                                     |   | 180 |   |
| Common                stock, $0.01 par value, authorized 30,000,000 shares                issued and outstanding: 20,386,816 shares at                  |   |                                           |    |                                     |   |   |   |
| December                31, 2006 and                19,127,065 shares at December 31, 2005                                                              |   |                                           | 204     |                                     |   | 191 |   |
| Warrants                                                                                                                                                |   |                                           | ---     |                                     |   | 9 |   |
| Additional                paid-in capital                                                                                                               |   |                                           | 73,597  |                                     |   | 66,015 |   |
| Accumulated                deficit                                                                                                                      |   |                                           | (68,479 | )                                        |   | (60,988 | ) |
| Total                stockholders’ equity                                                                                                         |   |                                           | 5,502   |                                     |   | 5,407 |   |
| **Total                Liabilities and Stockholders’ Equity**                                                                                     |   | $                                              | 24,511  |                                     | $      | 19,215 |   |
|                                                                                                                                                    |   |                                           |    |                                     |   |   |   |
| ***The                Notes to the Condensed Consolidated Financial Statements are an integral                part of this                statement.*** |

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**NESTOR,      INC.**

**Consolidated      Statements of Operations**

|                                                                                                                                                    |   | **Year                Ended December 31,**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|
|                                                                                                                                                    |   |  **2006**                                   |   |  **2005** |   |  **2004** |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |  (As                restated)  |   |
| Revenues:                                                                                                                                               |   |                                             |   |   |   |   |   |   |   |   |
| Lease                and service fees                                                                                                                   |   | $                                                | 8,079 |   | $ | 5,975 |   | $ | 5,118 |   |
| Product                sales                                                                                                                            |   |                                             | --- |   |   | 1,758 |   |   | 880 |   |
| Product                royalties                                                                                                                        |   |                                             | 8 |   |   | 36 |   |   | 37 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Total                revenue                                                                                                                            |   |                                             | 8,087 |   |   | 7,769 |   |   | 6,035 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Cost                of sales:                                                                                                                           |   |                                             |   |   |   |   |   |   |   |   |
| Lease                and service fees                                                                                                                   |   |                                             | 6,313 |   |   | 4,341 |   |   | 3,323 |   |
| Product                sales                                                                                                                            |   |                                             | --- |   |   | 1,391 |   |   | 609 |   |
| Product                royalties                                                                                                                        |   |                                             | --- |   |   | --- |   |   | --- |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Total                cost of sales                                                                                                                      |   |                                             | 6,313 |   |   | 5,732 |   |   | 3,932 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Gross                profit:                                                                                                                            |   |                                             |   |   |   |   |   |   |   |   |
| Lease                and service fees                                                                                                                   |   |                                             | 1,766 |   |   | 1,634 |   |   | 1,795 |   |
| Product                sales                                                                                                                            |   |                                             | --- |   |   | 367 |   |   | 271 |   |
| Product                royalties                                                                                                                        |   |                                             | 8 |   |   | 36 |   |   | 37 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Total                gross profit                                                                                                                       |   |                                             | 1,774 |   |   | 2,037 |   |   | 2,103 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Operating                expenses:                                                                                                                      |   |                                             |   |   |   |   |   |   |   |   |
| Engineering                and operations                                                                                                               |   |                                             | 4,373 |   |   | 4,050 |   |   | 3,465 |   |
| Research                and development                                                                                                                 |   |                                             | 1,383 |   |   | 1,737 |   |   | 157 |   |
| Selling                and marketing                                                                                                                    |   |                                             | 2,180 |   |   | 2,057 |   |   | 874 |   |
| General                and administrative                                                                                                               |   |                                             | 5,374 |   |   | 3,470 |   |   | 2,254 |   |
| Impairment                charge for long-lived assets                                                                                                  |   |                                             | 2,366 |   |   | --- |   |   | --- |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Total                operating expenses                                                                                                                 |   |                                             | 15,676 |   |   | 11,314 |   |   | 6,750 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Loss                from operations                                                                                                                     |   |                                             | (13,902 | ) |   | (9,277 | ) |   | (4,647 | ) |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Derivative                instrument income (expense)                                                                                                   |   |                                             | 16,940 |   |   | 7,780 |   |   | (1,341 | ) |
| Debt                discount expense                                                                                                                    |   |                                             | (8,664 | ) |   | (4,054 | ) |   | (364 | ) |
| Other                (expense) income, net                                                                                                              |   |                                             | (1,865 | ) |   | (704 | ) |   | (334 | ) |
| (Loss)                on debt refinancing                                                                                                               |   |                                             | --- |   |   | (509 | ) |   | --- |   |
| Gain                on debt extinguishment, net                                                                                                         |   |                                             | --- |   |   | --- |   |   | 508 |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Net                income (loss)                                                                                                                        |   | $                                                | (7,491 | ) | $ | (6,764 | ) | $ | (6,178 | ) |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Income                (loss) per share:                                                                                                                 |   |                                             |   |   |   |   |   |   |   |   |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Income                (loss) per share, basic and diluted                                                                                               |   | $                                                | (0.37 | ) | $ | (0.36 | ) | $ | (0.34 | ) |
|                                                                                                                                                    |   |                                             |   |   |   |   |   |   |   |   |
| Shares                used in computing loss per share:                                                                                                 |   |                                             |   |   |   |   |   |   |   |   |
| Basic                and diluted                                                                                                                        |   |                                             | 20,277,770 |   |   | 18,826,966 |   |   | 18,223,609 |   |
|                                                                                                                                                    |
| ***The                Notes to the Condensed Consolidated Financial Statements are an integral                part of this                statement.*** |

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**NESTOR,      INC.**

**Consolidated      Statements of Stockholders’ Equity**

**For      the Years Ended December 31, 2006, 2005 and 2004**

|                                                                    |   |   |                                   |   |   |                                                  |   |   |           |   |   |          |   |   |           |   |  Additional    |          | Stock  |   |           |   |   |          |   |   |
|-------------------------------------------------------------------------|--------|--------|----------------------------------------|--------|--------|-------------------------------------------------------|--------|--------|----------------|--------|--------|---------------|--------|--------|----------------|--------|-------------------------------|---------------|-------------|--------|----------------|--------|--------|---------------|--------|--------|
|                                                                    |   |   | Preferred                  Stock  |   |   | Common                  Stock     |   |   |           |   |   | Paid-In  |   |   | Pending   |   |  Accumulated   |          |        |   |
|                                                                    |   |   | Shares                            |   |   | Amount                                           |   |   | Shares    |   |   | Amount   |   |   | Warrants  |   |                          | Capital  |        |   | Issuance  |   |   | Deficit  |   |   | Total  |   |
|                                                                    |   |   |                                   |   |   |                                                  |   |   |           |   |   |          |   |   |           |   |                          |          |        |   |           |   |   |          |   |   |   |   |
| **Balance                  at December 31, 2003 -- Restated**           |   |   | **190,000**                            |   | **$**  | **190**                                               |   |   | **13,997,238** |   | **$**  | **140**       |   | **$**  | **1,377**      |   | **$**                         | **49,231**    |        | **$**  | **6,336**      |   | **$**  | **(48,046**   | **)**  | **$**  | **9,228** |   |
|                                                                    |   |   |                                   |   |   |                                                  |   |   |           |   |   |          |   |   |           |   |                          |          |        |   |           |   |   |          |   |   |   |   |
| Issuance                  of Common Stock                               |   |   | ---                                    |   |   | ---                                                   |   |   | 3,519,384      |   |   | 35            |   |   | ---            |   |                          | 9,721         |        |   | (6,336         | )      |   | ---           |   |   | 3,420 |   |
| Conversion                  of notes payable                            |   |   | ---                                    |   |   | ---                                                   |   |   | 865,761        |   |   | 9             |   |   | ---            |   |                          | 2,605         |        |   | ---            |   |   | ---           |   |   | 2,614 |   |
| Exercise                  of cashless warrants                          |   |   | ---                                    |   |   | ---                                                   |   |   | 262,115        |   |   | 3             |   |   | ---            |   |                          | (3            | )           |   | ---            |   |   | ---           |   |   | --- |   |
| Exercise                  of incentive stock options                    |   |   | ---                                    |   |   | ---                                                   |   |   | 28,000         |   |   | ---           |   |   | ---            |   |                          | 38            |        |   | ---            |   |   | ---           |   |   | 38 |   |
| Conversion                  of Preferred Stock to Common Stock          |   |   | (10,000                                | )      |   | (10                                                   | )      |   | 1,000          |   |   | ---           |   |   | ---            |   |                          | 10            |        |   | ---            |   |   | ---           |   |   | --- |   |
| Accretion                  value of warrants                            |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | 62             |   |                          | ---           |        |   | ---            |   |   | ---           |   |   | 62 |   |
| Expired                  warrants                                       |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | (1,225         | )      |                          | 1,225         |        |   | ---            |   |   | ---           |   |   | --- |   |
| Variable                  warrants                                      |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | (148           | )      |                          | 148           |        |   | ---            |   |   | ---           |   |   | --- |   |
| Loss                  for the year ended December 31, 2004              |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | ---           |        |   | ---            |   |   | (6,178        | )      |   | (6,178 | ) |
| **Balance                  at December 31, 2004 - Restated**            |   |   | **180,000**                            |   | **$**  | **180**                                               |   |   | **18,673,498** |   | **$**  | **187**       |   | **$**  | **66**         |   | **$**                         | **62,975**    |        | **$**  | **---**        |   | **$**  | **(54,224**   | **)**  | **$**  | **9,184** |   |
|                                                                    |   |   |                                   |   |   |                                                  |   |   |           |   |   |          |   |   |           |   |                          |          |        |   |           |   |   |          |   |   |   |   |
| Issuance                  of Common Stock                               |   |   | ---                                    |   |   | ---                                                   |   |   | 203,774        |   |   | 2             |   |   | ---            |   |                          | 1,078         |        |   | ---            |   |   | ---           |   |   | 1,080 |   |
| Conversion                  of notes payable                            |   |   | ---                                    |   |   | ---                                                   |   |   | 137,456        |   |   | 1             |   |   | ---            |   |                          | 799           |        |   | ---            |   |   | ---           |   |   | 800 |   |
| Exercise                  of incentive stock options                    |   |   | ---                                    |   |   | ---                                                   |   |   | 100,844        |   |   | 1             |   |   | ---            |   |                          | 226           |        |   | ---            |   |   | ---           |   |   | 227 |   |
| Exercise                  of warrants                                   |   |   | ---                                    |   |   | ---                                                   |   |   | 11,493         |   |   | ---           |   |   | ---            |   |                          | 5             |        |   | ---            |   |   | ---           |   |   | 5 |   |
| Variable                  warrants                                      |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | (57            | )      |                          | 57            |        |   | ---            |   |   | ---           |   |   | --- |   |
| Issuance                  of warrants                                   |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | 705           |        |   | ---            |   |   | ---           |   |   | 705 |   |
| Issuance                  of Laurus Note beneficial conversion features |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | 38            |        |   | ---            |   |   | ---           |   |   | 38 |   |
| Issuance                  of Stock Options for sales commissions        |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | 132           |        |   | ---            |   |   | ---           |   |   | 132 |   |
| Loss                  for the year ended December 31, 2005              |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | ---           |        |   | --             |   |   | (6,764        | )      |   | (6,764 | ) |
| **Balance                  at December 31, 2005**                       |   |   | **180,000**                            |   | **$**  | **180**                                               |   |   | **19,127,065** |   | **$**  | **191**       |   | **$**  | **9**          |   | **$**                         | **66,015**    |        | **$**  | **---**        |   | **$**  | **(60,988**   | **)**  | **$**  | **5,407** |   |
|                                                                    |   |   |                                   |   |   |                                                  |   |   |           |   |   |          |   |   |           |   |                          |          |        |   |           |   |   |          |   |   |   |   |
| Issuance                  of Common Stock                               |   |   | ---                                    |   |   | ---                                                   |   |   | 1,237,811      |   |   | 12            |   |   | ---            |   |                          | 4,810         |        |   | ---            |   |   | ---           |   |   | 4,822 |   |
| Issuance                  of Restricted Common Stock                    |   |   | ---                                    |   |   | ---                                                   |   |   | 20,000         |   |   | 1             |   |   | ---            |   |                          | 46            |        |   | ---            |   |   | ---           |   |   | 47 |   |
| Exercise                  of incentive stock options                    |   |   | ---                                    |   |   | ---                                                   |   |   | 1,940          |   |   | ---           |   |   | ---            |   |                          | 3             |        |   | ---            |   |   | ---           |   |   | 3 |   |
| Variable                  warrants                                      |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | (9             | )      |                          | 9             |        |   | ---            |   |   | ---           |   |   | --- |   |
| Issuance                  of warrants                                   |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | 208           |        |   | ---            |   |   | ---           |   |   | 208 |   |
| Stock                  expense compensation                             |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | 2,506         |        |   | ---            |   |   | ---           |   |   | 2,506 |   |
| Loss                  for the year ended December 31, 2006              |   |   | ---                                    |   |   | ---                                                   |   |   | ---            |   |   | ---           |   |   | ---            |   |                          | ---           |        |   | ---            |   |   | (7,491        | )      |   | (7,491 | ) |
| **Balance                  at December 31, 2006**                       |   |   | **180,000**                            |   | **$**  | **180**                                               |   |   | **20,386,816** |   | **$**  | **204**       |   | **$**  | **---**        |   | **$**                         | **73,597**    |        | **$**  | **---**        |   | **$**  | **(68,479**   | **)**  | **$**  | **5,502** |   |

***See      Notes to the Consolidated Financial Statements.***

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Table          of Contents

**NESTOR,      INC.**

**Consolidated      Statements of Cash Flows**

|                                                                                                      |   | ** Years                Ended December 31,** |
|-----------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------|
|                                                                                                      |   |  **2006**                                    | ** ** | ** 2005** | ** ** | ** 2004** |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   | **(As                Restated)**  |   |
| **Cash                flows from operating activities:**                                                  |   |                                              |   |   |   |   |   |   |   |   |
| Net                loss                                                                                   |   | $                                                 | (7,491 | ) | $ | (6,764 | ) | $ | (6,178 | ) |
| Adjustments                to reconcile net loss to net cash used                by operating activities: |   |                                              |   |   |   |   |   |   |   |   |
| Depreciation                and amortization                                                              |   |                                              | 2,975 |   |   | 2,398 |   |   | 2,037 |   |
| Asset                impairment charges                                                                   |   |                                              | 2,366 |   |   | --- |   |   | --- |   |
| Stock                based compensation                                                                   |   |                                              | 2,552 |   |   | --- |   |   | --- |   |
| Amortization                and write-off of deferred financing fees                                      |   |                                              | 900 |   |   | 321 |   |   | 116 |   |
| Derivative                instrument income expense                                                       |   |                                              | (16,940 | ) |   | (7,780 | ) |   | 1,341 |   |
| Debt                discount expense                                                                      |   |                                              | 8,664 |   |   | 4,054 |   |   | 364 |   |
| Loss                on disposal of fixed assets                                                           |   |                                              | --- |   |   | --- |   |   | 5 |   |
| (Gain)                on extinguishment of debt, net                                                      |   |                                              | --- |   |   | --- |   |   | (508 | ) |
| Loss                on debt refinancing                                                                   |   |                                              | --- |   |   | 509 |   |   | --- |   |
| Unrealized                loss on marketable securities                                                   |   |                                              | (2 | ) |   | 14 |   |   | 10 |   |
| Realized                loss on marketable securities                                                     |   |                                              | --- |   |   | --- |   |   | 96 |   |
| Dividends                reinvested                                                                       |   |                                              | --- |   |   | (89 | ) |   | (35 | ) |
| Expenses                charged to operations relating to                                                 |   |                                              |   |   |   |   |   |   |   |   |
| options,                warrants and capital transactions                                                 |   |                                              | --- |   |   | 367 |   |   | 62 |   |
| Provision                for doubtful accounts                                                            |   |                                              | 63 |   |   | 80 |   |   | 34 |   |
| Provision                for inventory reserves                                                           |   |                                              | 157 |   |   | 317 |   |   | 50 |   |
| Increase                (decrease) in cash arising from changes                in assets and liabilities: |   |                                              |   |   |   |   |   |   |   |   |
| Accounts                receivable, net                                                                   |   |                                              | (457 | ) |   | (1,258 | ) |   | (276 | ) |
| Unbilled                contract revenue                                                                  |   |                                              | --- |   |   | 111 |   |   | 48 |   |
| Inventory,                net                                                                             |   |                                              | (435 | ) |   | (752 | ) |   | (650 | ) |
| Other                assets                                                                               |   |                                              | 195 |   |   | (597 | ) |   | (612 | ) |
| Accounts                payable and accrued expenses                                                      |   |                                              | 523 |   |   | 1,329 |   |   | 163 |   |
| Deferred                revenue                                                                           |   |                                              | 608 |   |   | (42 | ) |   | 125 |   |
| Restructuring                reserve                                                                      |   |                                              | --- |   |   | --- |   |   | (147 | ) |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Net                cash used for operating activities                                                     |   |                                              | (6,322 | ) |   | (7,782 | ) |   | (3,955 | ) |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| **Cash                flows from investing activities:**                                                  |   |                                              |   |   |   |   |   |   |   |   |
| Investment                in marketable securities                                                        |   |                                              | --- |   |   | --- |   |   | (1,500 | ) |
| Liquidation                of marketable securities                                                       |   |                                              | --- |   |   | 591 |   |   | 857 |   |
| Purchase                of Transol assets                                                                 |   |                                              | --- |   |   | (1,760 | ) |   | --- |   |
| Investment                in capitalized systems                                                          |   |                                              | (6,270 | ) |   | (3,562 | ) |   | (1,829 | ) |
| Purchase                of property and equipment                                                         |   |                                              | (339 | ) |   | (799 | ) |   | (232 | ) |
| Investment                in patent development costs                                                     |   |                                              | (3 | ) |   | (7 | ) |   | (7 | ) |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Net                cash used for investing activities                                                     |   |                                              | (6,612 | ) |   | (5,537 | ) |   | (2,711 | ) |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| **Cash                flows from financing activities:**                                                  |   |                                              |   |   |   |   |   |   |   |   |
| Repayment                of obligations under capital leases                                              |   |                                              | --- |   |   | (39 | ) |   | (2,260 | ) |
| Proceeds                from notes payable                                                                |   |                                              | 26,397 |   |   | 14,500 |   |   | 6,098 |   |
| Repayment                of note payable                                                                  |   |                                              | (16,560 | ) |   | (6,000 | ) |   | (195 | ) |
| Proceeds                from private stock placement                                                      |   |                                              | 4,822 |   |   | --- |   |   | --- |   |
| Proceeds                from issuance of common stock, net                                                |   |                                              | 3 |   |   | 232 |   |   | 3,463 |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Net                cash provided by financing activities                                                  |   |                                              | 14,662 |   |   | 8,693 |   |   | 7,106 |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Net                change in cash and cash equivalents                                                    |   |                                              | 1,728 |   |   | (4,626 | ) |   | 440 |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Cash                and cash equivalents - beginning of year                                              |   |                                              | 1,224 |   |   | 5,850 |   |   | 5,410 |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Cash                and cash equivalents - end of year                                                    |   | $                                                 | 2,952 |   | $ | 1,224 |   | $ | 5,850 |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| **Supplemental                cash flows information:**                                                   |   |                                              |   |   |   |   |   |   |   |   |
| Interest                paid                                                                              |   | $                                                 | 1,426 |   | $ | 846 |   | $ | 93 |   |
|                                                                                                      |   |                                              |   |   |   |   |   |   |   |   |
| Income                taxes paid                                                                          |   | $                                                 | --- |   | $ | --- |   | $ | --- |   |

***Significant      non-cash transactions are further described in Notes 7, 8, and      11.***

***See      Notes to the Consolidated Financial Statements.***

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                1 -** | **Nature                of operations** |
|-----------------------------|-----------------------------------------|

| *A.* | *Organization* |
|------|----------------|

| B. | *Liquidity                and management’s plans* |
|----|---------------------------------------------------------|

| **Note                2 -** | **Summary                of significant accounting                policies:** |
|-----------------------------|-------------------------------------------------------------------------------|

| A. | *Cash                equivalents* |
|----|-----------------------------------|

| *B.* | *Marketable                securities* |
|------|----------------------------------------|

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| C. | *Accounts                receivable* |
|----|--------------------------------------|

| D. | *Unbilled                contract revenue* |
|----|--------------------------------------------|

| E. | *Inventory* |
|----|-------------|

| F. | *Property                and equipment & depreciation and                amortization* |
|----|--------------------------------------------------------------------------------------------|

| G. | *Goodwill* |
|----|------------|

| H. | *Product                and patent development costs* |
|----|-------------------------------------------------------|

| I. | *Revenue                recognition* |
|----|--------------------------------------|

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

|   | a) | We                provide hardware and equipment, and related third party embedded                software                (“roadside systems”). The third party embedded software is considered                incidental to the system as a whole. In these arrangements, we typically                sell or lease the system as a stand alone roadside system and account                for                it either as a direct sale, in one instance as a sales type lease,                as it                met the criteria of a sales type lease in Financial Accounting Standards                Board (FASB) Statement of Financial Accounting Standards (FAS) No.                13 -                Accounting for Leases, or in most other cases as an operating lease                accounted for on a monthly basis. For each arrangement, usually upon                delivery for the sales type lease or monthly for operating type leases,                revenue is recognized as there exists evidence that an arrangement                exists,                the system is delivered, the price is fixed or determinable, and                collectability is reasonably assured in accordance with SAB                104; |
|--------|----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | b) | We                provide services, which typically include citation processing, back                office                and hosting services. Software is more than incidental to the services                as                a whole, but 1) is used by us to capture and internally process the                violations and 2) customers do not have the right to and do not take                possession of our detection and tracking, or our citation processing                and                back office software. For these services, we typically recognize                revenue                on a fixed monthly fee or a per citation fee basis. Revenue usually                commences for these service arrangements, upon the first month after                inception of operations, as there exists evidence that an arrangement                exists, services have been rendered or delivered (citations and other                services are delivered), the price is fixed or determinable, and                collectability is reasonably assured;                and |
|--------|----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | c) | For                two current customers who want to process their own citations, we                lease                them our detection and tracking and citation processing and back                office                software and provide monthly customer support on the software. For                these                arrangements, we recognize revenue in accordance with Statement of                Position 97 -2 Software Revenue Recognition. Although all software                deliverables are complete in the initial month of operations, and                the                monthly customer support is the only undelivered element, we recognize                revenue on a monthly basis as the citations are                issued. |
|--------|----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| J. | *Deferred                Revenue* |
|----|-----------------------------------|

| K. | *Shipping                and handling costs* |
|----|----------------------------------------------|

| L. | *Research                and development* |
|----|-------------------------------------------|

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| M. | *Impairment                of long lived assets* |
|----|--------------------------------------------------|

| N. | *Income                taxes* |
|----|-------------------------------|

| O. | *Earnings                (loss) per share and common                stock* |
|----|----------------------------------------------------------------------------|

| P. | *Estimates* |
|----|-------------|

| Q. | *Concentrations                of credit risk* |
|----|------------------------------------------------|

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| R. | *Stock                option plans* |
|----|-------------------------------------|

*“Share-Based      Payment,” *
*“Accounting      for Stock Issued to Employees,”*

| S. | *Asset                retirement obligations* |
|----|-----------------------------------------------|

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

|                                        |   |  December                31, |   |
|---------------------------------------------|--------|-----------------------------------|--------|
|                                        |   |  2006                   |   |  2005  |   |
|                                        |   |                              |   |   |   |   |   |
| Balance                at beginning of year |   | $                                 | 194    |   | $ | 158 |   |
| ARO                incurred                 |   |                              | 423    |   |   | 21 |   |
| Accretion                expense            |   |                              | 57     |   |   | 15 |   |
| ARO                settled                  |   |                              | ---    |   |   | --- |   |
| Revisions                to ARO estimates   |   |                              | ---    |   |   | --- |   |
|                                        |   |                              |   |   |   |   |   |
| Balance                at the end of year   |   | $                                 | 674    |   | $ | 194 |   |

| T. | *Deferred                Rent* |
|----|--------------------------------|

| U*.* | *Derivative                Instruments* |
|------|-----------------------------------------|

| V. | *Advertising* |
|----|---------------|

| W. | *Reclassification* |
|----|--------------------|

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                3 -** | **Restatement                of Consolidated Financial                Statements:** |
|-----------------------------|-------------------------------------------------------------------------------------|

| · | The                principal conversion options. |
|--------|--------------------------------------------------|

| · | The                monthly payments conversion                options. |
|--------|------------------------------------------------------------------------|

| · | The                interest rate adjustment                provisions. |
|--------|------------------------------------------------------------------------|

|                                         |   |   | Net                Loss         |   |
|----------------------------------------------|--------|--------|--------------------------------------|--------|
|                                         |   |   | Year                Ended       |   |
|                                         |   |   | December              31, 2004  |   |
|                                         |   |   |                                 |   |
| As                previously reported        |   | $      | (4,473                               | )      |
|                                         |   |   |                                 |   |
| Restatement                adjustments, net: |   |   |                                 |   |
| Derivative                instrument expense |   | $      | (1,705                               | )      |
|                                         |   |   |                                 |   |
| As                restated                   |   | $      | (6,178                               | )      |

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*Impact      of the Financial Statement Adjustments on the Consolidated Statements of      Operations*

|                                                                         |   | Years                Ended December 31, |
|------------------------------------------------------------------------------|--------|-----------------------------------------|
|                                                                         |   |                                    | 2004 |   |   | 2004 |   |
|                                                                         |   |                                    | (As                reported)  |   |   | (As                restated) |   |
|                                                                         |   |                                    |   |   |   |   |   |
| Loss                from operations                                          |   | $                                       | (4,647 | ) | $ | (4,647 | ) |
| Gain                on debt extinguishment, net                              |   |                                    | 508 |   |   | 508 |   |
| (Loss)                on debt refinancing                                    |   |                                    | --- |   |   | --- |   |
| Other                (expense) income, net                                   |   |                                    | (334 | ) |   | (334 | ) |
| Derivative                instrument expense                                 |   |                                    | --- |   |   | (1,705 | ) |
| Net                Loss                                                      |   | $                                       | (4,473 | ) | $ | (6,178 | ) |
|                                                                         |   |                                    |   |   |   |   |   |
| Basic                and diluted net loss per share:                         |   | $                                       | (0.25 | ) | $ | (0.34 | ) |
| Shares                used in computing basic and diluted net loss per share |   |                                    | 18,223,609 |   |   | 18,223,609 |   |

| **Note                4 -** | **Capitalized                system costs:** |
|-----------------------------|----------------------------------------------|

|                                              |   | December                31,  |
|---------------------------------------------------|--------|-----------------------------------|
|                                              |   |                              | 2006 |   |   | 2005 |   |
| Equipment                under operating leases:  |   |                              |   |   |   |   |   |
| Work-in-process                                   |   | $                                 | 3,312 |   | $ | 1,019 |   |
| Installed                and accepted             |   |                              | 13,232 |   |   | 9,255 |   |
|                                              |   |                              | 16,544 |   |   | 10,274 |   |
|                                              |   |                              |   |   |   |   |   |
| Less:                Accumulated depreciation     |   |                              | (8,359 | ) |   | (4,895 | ) |
| Net                investment in leased equipment |   | $                                 | 8,185 |   | $ | 5,379 |   |

----

Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                5 -** | **Property                and equipment - net:** |
|-----------------------------|--------------------------------------------------|

|                                           |                                  |   | December                31,  |
|------------------------------------------------|---------------------------------------|--------|-----------------------------------|
|                                           | Depreciable                Life  |   |                              | 2006 |   |   | 2005 |   |
|                                           |                                  |   |                              |   |   |   |   |   |
| Office                furniture and equipment  | 3                years                |   | $                                 | 478 |   | $ | 460 |   |
| Computer                equipment and software | 1-5                years              |   |                              | 2,389 |   |   | 2,157 |   |
| Demonstration                equipment         | 3                years                |   |                              | 127 |   |   | 81 |   |
| Leasehold                improvements          | 5                years                |   |                              | 592 |   |   | 549 |   |
|                                           |                                  |   |                              | 3,586 |   |   | 3,247 |   |
| Less:                Accumulated depreciation  |                                  |   |                              | (2,797 | ) |   | (2,322 | ) |
|                                           |                                  |   | $                                 | 789 |   | $ | 925 |   |

| **Note                6 -** | **Goodwill                and other intangible assets,                net:** |
|-----------------------------|------------------------------------------------------------------------------|

| Identified                  Intangible Asset                                                                       |   |   | Useful                  Life In Years |   |   | Gross                  Carrying Amount |   | Accumulated                  Amortization |   |   | Net                  Carrying                  Amount |   |
|--------------------------------------------------------------------------------------------------------------------|--------|--------|---------------------------------------|--------|--------|----------------------------------------|--------|-------------------------------------------|--------|--------|-------------------------------------------------------|--------|
|                                                                                                               |   |   |                                  |   |   |                                   |   |                                      |   |   |                                                  |   |   |   |   |   |   |
| Patents                                                                                                            |   |   | 7                                     |   | $      | 206                                    |   |                                      |   |   | $                                                     | (81    | ) |   | $ | 125 |   |
| Customer                  contracts and related customer relationships (included in Other                  Assets) |   |   | 1-5                                   |   |   | 1,337                                  |   |                                      |   |   |                                                  | (1,326 | ) |   |   | 11 |   |
| Total                                                                                                              |   |   |                                  |   | $      | 1,543                                  |   |                                      |   |   | $                                                     | (1,407 | ) |   | $ | 136 |   |

| Fiscal                Year  |   |   |   | Estimated                Amortization                Expense  |   |
|----------------------------------|--------|--------|--------|--------------------------------------------------------------------|--------|
|                             |   |   |   |                                                               |   |
| 2007                             |   |   |   | 6                                                                  |   |
| 2008                             |   |   |   | 5                                                                  |   |
| Total                       |   |   | $      | 11                                                                 |   |

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                7 -** | **Long                Term Obligations:** |
|-----------------------------|-------------------------------------------|

|   |                                                           |   |   | December                31, 2006  |   |   | December                31, 2005 |   |
|--------|----------------------------------------------------------------|--------|--------|----------------------------------------|--------|--------|----------------------------------|--------|
|   |                                                           |   |   |                                   |   |   |                             |   |
|   | 5%                Senior Convertible Notes                     |   |   |                                   |   |   |                             |   |
|   | Principal                                                      |   | $      | 2,850                                  |   | $      | 5,200                            |   |
|   | Debt                discount                                   |   |   | (1,930                                 | )      |   | (3,550                           | )      |
|   | FMV                of embedded derivatives                     |   |   | 164                                    |   |   | 1,419                            |   |
|   |                                                           |   |   |                                   |   |   |                             |   |
|   | 7%                Senior Secured Convertible Notes             |   |   |                                   |   |   |                             |   |
|   | Principal                                                      |   |   | 22,840                                 |   |   | ---                              |   |
|   | Debt                discount                                   |   |   | (14,277                                | )      |   | ---                              |   |
|   | FMV                of embedded derivatives, including warrants |   |   | 4,807                                  |   |   | ---                              |   |
|   |                                                           |   |   |                                   |   |   |                             |   |
|   | Foundation                Partners Secured Promissory Note     |   |   | ---                                    |   |   | 1,250                            |   |
|   | Heil                Secured Promissory Note                    |   |   | ---                                    |   |   | 1,250                            |   |
|   |                                                           |   |   |                                   |   |   |                             |   |
|   | Fourth                Laurus Note                              |   |   |                                   |   |   |                             |   |
|   | Principal                                                      |   |   | ---                                    |   |   | 6,000                            |   |
|   | Debt                discount                                   |   |   | ---                                    |   |   | (1,078                           | )      |
|   |                                                           |   | $      | 14,454                                 |   | $      | 10,491                           |   |
|   | Less                current portion                            |   |   | ---                                    |   |   | 4,136                            |   |
|   | Total                                                          |   | $      | 14,454                                 |   | $      | 6,355                            |   |

|   |                                               |   |   | 2009   |   |   | 2011   |   |   | Total  |   |
|--------|----------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|   |                                               |   |   |   |   |   |   |   |   |   |   |
|   | 7%                Senior Secured Convertible Notes |   | $      | ---    |   | $      | 22,840 |   | $      | 22,840 |   |
|   | 5%                Senior Convertible Notes         |   |   | 2,850  |   |   | ---    |   |   | 2,850  |   |
|   | Total:                                             |   | $      | 2,850  |   | $      | 22,840 |   | $      | 25,690 |   |

*7%      Senior Secured Convertible Notes*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*pari      passu*
*Share-Based      Payment*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*Fourth      Laurus Note:*

*Heil      Secured Promissory Note:*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*Foundation      Partners Secured Promissory Note:*

*Third      Laurus Convertible Note:*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*5%      Senior Convertible Notes*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

** **

*Second      Laurus Convertible Note:*

*First      Laurus Convertible Note:*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*Embedded      Derivatives and Debt Discounts*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| · | Principal’s                Conversion Options |
|--------|-----------------------------------------------------|

| · | Monthly                Payment Conversion Options |
|--------|---------------------------------------------------|

| · | Interest                Rate Adjustment provisions |
|--------|----------------------------------------------------|

| **Note                8 -** | **Transol                Asset Purchase:** |
|-----------------------------|--------------------------------------------|

| · | Contracts                to provide automated red light enforcement services in six US cities                at an                aggregate of 39                approaches, of which 35 were fully installed and                operating. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Equipment                located at the contracted approaches used for providing automated                red                light enforcement services. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Transol’s                intellectual property, including one U.S., one Australian and one                international patent application (each related to the technology                underlying their red light enforcement services, the Transol website,                computer source code for Transol’s products and services and all other                “technical know how,” except that relating to Transol’s automated driver’s                licensing testing business). |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | Inventory,                work in process, accounts receivable and unbilled contract revenue                related                to Transol’s red light enforcement                services. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| · | The                goodwill of the Transol business, except that relating to the automated                driver’s licensing testing                business. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| Gross                    purchase price:                                                                                                                                                                                          |   | $      | 2,000  |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
|                                                                                                                                                                                                                              |   |   |   |   |
| Adjustment                    for contracts not expected to be assigned:                                                                                                                                                          |   |   |   |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Uninstalled                    approaches                                                                                                                                                                                         |   |   | 12     |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Price                    adjustment per approach                                                                                                                                                                                  |   |   | (20    | )      |
|                                                                                                                                                                                                                              |   |   |   |   |
| Total                    purchase price adjustment                                                                                                                                                                                |   |   | (240   | )      |
|                                                                                                                                                                                                                              |   |   |   |   |
| Adjusted                    purchase price                                                                                                                                                                                        |   | $      | 1,760  |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Purchase                    price allocation:                                                                                                                                                                                     |   |   |   |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Accounts                    receivable                                                                                                                                                                                            |   | $      | 7      |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Inventory                                                                                                                                                                                                                         |   |   | 204    |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Capitalized                    system costs1                                                                                                                                                                                      |   |   | 118    |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Property                    and equipment1                                                                                                                                                                                        |   |   | 94     |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| Contracts                    (intangible other assets)1                    Weighted-average                    amortization period of 52 months                                                                                   |   |   | 1,337  |   |
|                                                                                                                                                                                                                              |   |   |   |   |
|                                                                                                                                                                                                                              |   | $      | 1,760  |   |
|                                                                                                                                                                                                                              |   |   |   |   |
| 1  These                    assets received a fair value allocation reduction totaling $95,                    due to                    fair value in excess of the $1,760 adjusted purchase                    price. |

| **Note                9 -** | **Leases                payable:** |
|-----------------------------|------------------------------------|

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                10 -** | **Common                and preferred stock:**  |
|------------------------------|------------------------------------------------------|

*Private      Stock Placement*

*Private      Placement and Silver Star Note Conversion:*

*Laurus      Note Conversions:*

*One-for-Ten      Reverse Stock Split:*

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

*Preferred      Stock:*

| **Note                11 -** | **Options                and warrants:** |
|------------------------------|------------------------------------------|

*“Share-Based      Payment,” *
*“Accounting      for Stock Issued to Employees,”*

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Table          of Contents

**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

|                                                       |   |  Twelve                Months Ended  |
|------------------------------------------------------------|--------|------------------------------------------------|
|                                                       |   |                                           | December                31, 2006  |
|                                                       |   |                                           |   |
| Cost                of sales                               |   | $                                              | 25 |
| Engineering                and operations                  |   |                                           | 291 |
| Research                and development                    |   |                                           | 119 |
| Selling                and marketing                       |   |                                           | 79 |
| General                and administrative                  |   |                                           | 1,992 |
| Share-based                compensation expense before tax |   | $                                              | 2,506 |
| Provision                for income tax                    |   |                                           | --- |
| Net                share-based compensation expense        |   | $                                              | 2,506 |

|                                              |   | Twelve                Months Ended |
|---------------------------------------------------|--------|------------------------------------|
|                                              |   | December                31, 2006   |
| Expected                option term (1)           |   | 5.25                years          |
| Expected                volatility factor (2)     |   | 164                to 169%         |
| Risk-free                interest rate (3)        |   | 4.3                to 5.0%         |
| Expected                annual dividend yield (4) |   | 0%                                 |

| (1) | The                option life was determined using the simplified method for estimating                expected option life, which qualify as “plain-vanilla”                options. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2) | The                stock volatility for each grant is determined based on the review                of the                experience of the weighted average of historical weekly price changes                of                the Company’s common stock over the expected option                term. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (3) | The                risk-free interest rate for periods equal to the expected term of                the                share option is based on the U. S. Treasury yield curve in effect                at the                time of grant. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (4) | The                Company has not paid a dividend historically nor plans to declare                a                dividend in the near future. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------|

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

|                                             |   |   | Year                Ended         |   |   | Year                Ended          |   |
|--------------------------------------------------|--------|--------|----------------------------------------|--------|--------|------------------------------------|--------|
|                                             |   |   | December                31, 2005  |   |   | December                31, 2004   |   |
|                                             |   |   |                                   |   |   | (As                Restated)  |   |
|                                             |   |   |                                   |   |   |                               |   |
| Net                loss, as restated             |   | $      | (6,764                                 | )      |   | (6,178                             | )      |
| Less:                Total employee compensation |   |   |                                   |   |   |                               |   |
| expenses                for options determined   |   |   |                                   |   |   |                               |   |
| under                the net fair value method   |   |   | (2,724                                 | )      |   | (4,913                             | )      |
| Pro                forma net loss                |   |   | (9,518                                 | )      |   | (11,091                            | )      |
|                                             |   |   |                                   |   |   |                               |   |
| Pro                forma net loss per share:     |   |   |                                   |   |   |                               |   |
| -                as restated                     |   | $      | (0.36                                  | )      | $      | (0.34                              | )      |
| -                pro forma                       |   | $      | (0.51                                  | )      | $      | (0.61                              | )      |

|                                   |   |   | Year                Ended         |   |   | Year                Ended        |   |
|----------------------------------------|--------|--------|----------------------------------------|--------|--------|----------------------------------|--------|
|                                   |   |   | December                31, 2005  |   |   | December                31, 2004 |   |
|                                   |   |   |                                   |   |   |                             |   |
| Expected                term           |   |   | 8                years                 |   |   | 8                years           |   |
| Volatility                             |   |   | 108                                    | %      |   | 113                              | %      |
| Risk-free                interest rate |   |   | 3.2                to 4.2              | %      |   | 1.6                to 6.6        | %      |
| Dividend                yield          |   |   | 0                                      | %      |   | 0                                | %      |

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

|                                           |   |  Year                Ended December 31, |
|------------------------------------------------|--------|----------------------------------------------|
|                                           |   |  2006                                   |   |   2005 |   |  2004 |
|                                           |   |                                         | Shares  |   |   | Weighted                Av. Ex. Price |   |   | Shares |   |   | Weighted                Av. Ex. Price |   |   | Shares |   |   | Weighted                Av. Ex. Price |
| Outstanding                beginning of year   |   |                                         | 2,866,027 |   | $ | 4.87 |   |   | 2,887,655 |   | $ | 4.71 |   |   | 312,397 |   | $ | 5.75 |
| Granted                                        |   |                                         | 559,000 |   |   | 3.11 |   |   | 474,665 |   |   | 5.63 |   |   | 2,777,650 |   |   | 4.66 |
| Exercised                                      |   |                                         | 1,940 |   |   | 1.80 |   |   | 100,844 |   |   | 3.99 |   |   | 28,000 |   |   | 1.34 |
| Canceled                                       |   |                                         | 469,234 |   |   | 4.80 |   |   | 395,449 |   |   | 4.81 |   |   | 174,392 |   |   | 6.28 |
| Outstanding                end of year         |   |                                         | 2,953,853 |   |   | 4.55 |   |   | 2,866,027 |   |   | 4.87 |   |   | 2,887,655 |   |   | 4.71 |
|                                           |   |                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Options                exercisable at year end |   |                                         | 1,884,028 |   | $ | 4.77 |   |   | 1,413,243 |   | $ | 4.79 |   |   | 1,010,236 |   | $ | 4.87 |

|  Options                Outstanding |                                   |  Options                Exercisable |
|------------------------------------------|----------------------------------------|------------------------------------------|
|                                     | Range                of Exercise Price |                                     | Number                of Outstanding at12-31-2006 |   | Weighted                Average Remaining Contractual Life                (Years) |   |   | Weighted                Average Exercise                Price |   | Number                Exercisable  at 12-31-2006 |   |   | Weighred                Averaged Exercisable Price |
| $                                        | 1.00                                   | -                                        | 2.99 |   | 342,150 |   | 9.0 |   | $ | 2.26 |   | 38,450 |   | $ | 1.96 |
|                                     | 3.00                                   | -                                        | 3.99 |   | 228,800 |   | 4.9 |   |   | 3.60 |   | 144,800 |   |   | 3.69 |
|                                     | 4.00                                   | -                                        | 4.99 |   | 2,076,575 |   | 6.5 |   |   | 4.86 |   | 1,576,075 |   |   | 4.87 |
|                                     | 5.00                                   | -                                        | 5.99 |   | 299,663 |   | 5.4 |   |   | 5.72 |   | 121,788 |   |   | 5.61 |
|                                     | 6.00                                   | -                                        | 8.00 |   | 6,665 |   | 5.2 |   |   | 6.20 |   | 2,915 |   |   | 6.13 |
|                                     |                                   |                                     |   |   | 2,953,853 |   | 6.6 |   | $ | 4.55 |   | 1,884,028 |   | $ | 4.77 |

*Warrants*

|                                                         |   |   |  Years                Ended December 31, |
|--------------------------------------------------------------|--------|--------|-----------------------------------------------|
|                                                         |   |   |  2006                                    |   |  2005 |   |  2004 |
|                                                         |   |   |                                          |   |   |   |   |   |   |   |
| Eligible,                end of year for exercise, currently |   |   |                                          | 2,925,601 |   |   | 178,331 |   |   | 80,611 |
|                                                         |   |   |                                          |   |   |   |   |   |   |   |
| Warrants                issued                               |   |   |                                          | 2,765,601 |   |   | 100,000 |   |   | 60,000 |
|                                                         |   |   |                                          |   |   |   |   |   |   |   |
| Low                exercise price                            |   |   | $                                             | 3.60 |   | $ | 4.80 |   | $ | 0.49 |
| High                exercise price                           |   |   | $                                             | 4.91 |   | $ | 8.43 |   | $ | 2.72 |

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                12 -** | **Segment                and geographic                information:** |
|------------------------------|-----------------------------------------------------------------------|

| **Note                13**                - | **Master                lease assignment****:** |
|---------------------------------------------|-------------------------------------------------|

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                14 -** | **Other                expense - net:** |
|------------------------------|-----------------------------------------|

|                                                    |   | Years                Ended December 31,  |
|---------------------------------------------------------|--------|-----------------------------------------------|
|                                                    |   |                                          | 2006 |   |   | 2005 |   |   | 2004 |   |
| Interest                and dividend income             |   | $                                             | 392 |   | $ | 113 |   | $ | 79 |   |
| Interest                expense                         |   |                                          | (1,925 | ) |   | (847 | ) |   | (239 | ) |
| Expense                relating to financing operations |   |                                          | (330 | ) |   | --- |   |   | (63 | ) |
| Unrealized                gain/(loss)                   |   |                                          | 8 |   |   | (3 | ) |   | (10 | ) |
| Realized                loss                            |   |                                          | --- |   |   | --- |   |   | (96 | ) |
| Other                income/(expense)                   |   |                                          | (10 | ) |   | 33 |   |   | --- |   |
| Gain                (Loss) on disposal of fixed assets  |   |                                          | --- |   |   | --- |   |   | (5 | ) |
| Other                expense - net                      |   | $                                             | (1,865 | ) | $ | (704 | ) | $ | (334 | ) |

| **Note                15 -** | **Income                taxes:** |
|------------------------------|----------------------------------|

| U.S.                federal statutory rate           |   |   | 34  | %  |
|------------------------------------------------------|--------|--------|-----|----|
| State                tax, net of federal tax benefit |   |   | 5   | %  |
| Provision                for valuation allowance     |   |   | (39 | %) |
| Effective                income tax rate             |   |   | 0   | %  |

| **Note                16 -** | **Related                party transactions:** |
|------------------------------|------------------------------------------------|

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                17 -** | **Commitments                and contingencies:** |
|------------------------------|---------------------------------------------------|

| **Payments                due in:** |   |   | **Non-Cancelable                Operating Leases****(1)** |   |
|-------------------------------------|--------|--------|-----------------------------------------------------------|--------|
| **2007**                            |   |   | 398                                                       |   |
| **2008**                            |   |   | 367                                                       |   |
| **2009**                            |   |   | 367                                                       |   |
| **2010**                            |   |   | 320                                                       |   |
| **2011**                            |   |   | 113                                                       |   |
| **Thereafter**                      |   |   | ---                                                       |   |
|                                |   | $      | 1,565                                                     |   |

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

|   |   |
|--------|--------|

| **Note                18 -** | **Litigation:** |
|------------------------------|-----------------|

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                19-** | **Quarterly                financial information                (unaudited):** |
|-----------------------------|--------------------------------------------------------------------------------|

|                                                                |   | **Year                Ended December 31, 2006**(As                Reported)  |
|---------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|
|                                                                |   |                                                                              | **First                Quarter**  |   |   | **Second                Quarter** |   |   | **Third                Quarter** |   |   | **Fourth                Quarter** |   |
| Revenues                                                            |   | $                                                                                 | 1,752 |   | $ | 2,004 |   | $ | 1,982 |   | $ | 2,349 |   |
| Gross                Profit                                         |   | $                                                                                 | 401 |   | $ | 300 |   | $ | 323 |   | $ | 576 |   |
| Net                income (loss)                                    |   | $                                                                                 | (3,492 | ) | $ | (4,004 | ) | $ | 2,648 |   | $ | (2,643 | ) |
| Basic                and diluted income (loss) per share            |   | $                                                                                 | (0.17 | ) | $ | (0.20 | ) | $ | 0.13 |   | $ | (0.13 | ) |
| Shares                used in computing net income (loss) per share |   |                                                                              |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                               |   |                                                                              | 19,979,780 |   |   | 20,365,812 |   |   | 20,378,648 |   |   | 20,386,816 |   |
| Diluted                                                             |   |                                                                              | 19,979,780 |   |   | 20,365,812 |   |   | 20,385,970 |   |   | 20,386,816 |   |

|                                                                                                |   | **Year                Ended December 31, 2005**  |
|-----------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------|
|                                                                                                |   | **First                Quarter**                 | **Second                Quarter** |
| (As                reported)                                                                        |   |                                                  | (As                reported)  |   |   | (As                restated) |   |   | (As                reported) |   |   | (As                restated) |   |
| Revenues                                                                                            |   | $                                                     | 1,852 |   | $ | 1,852 |   | $ | 2,414 |   | $ | 2,414 |   |
| Gross                Profit                                                                         |   | $                                                     | 660 |   | $ | 660 |   | $ | 678 |   | $ | 678 |   |
| Net                income (loss)                                                                    |   | $                                                     | (1,910 | ) | $ | 166 |   | $ | (2,325 | ) | $ | (3,444 | ) |
| Basic                and diluted income (loss) per share                                            |   | $                                                     | (0.10 | ) | $ | 0.01 |   | $ | (0.12 | ) | $ | (0.18 | ) |
| Shares                used in computing basic anddiluted                net income (loss) per share |   |                                                  | 18,751,942 |   |   | 18,751,942 |   |   | 18,815,049 |   |   | 18,815,049 |   |

|                                                                                         |   | **Third                Quarter**  |                               | **Fourth                Quarter** |   |                         | **Total** |   |
|----------------------------------------------------------------------------------------------|--------|----------------------------------------|------------------------------------|-----------------------------------|--------|------------------------------|-----------|--------|
|                                                                                         |   |                                   | (As                reported)  |                              |   | (As                restated) |      |   |   |   |   |   |   |
| Revenues                                                                                     |   | $                                      | 1,914                              |                              | $      | 1,914                        |      | $      | 1,589 |   | $ | 7,769 |   |
| Gross                Profit                                                                  |   | $                                      | 624                                |                              | $      | 624                          |      | $      | 75 |   | $ | 2,037 |   |
| Net                (loss)                                                                    |   | $                                      | (2,792                             | )                                 | $      | (2,217                       | )         | $      | (1,269 | ) | $ | (6,764 | ) |
| Basic                and diluted (loss) per share                                            |   | $                                      | (0.15                              | )                                 | $      | (0.12                        | )         | $      | (0.07 | ) | $ | (0.36 | ) |
| Shares                used in computing basic anddiluted                net (loss) per share |   |                                   | 18,879,464                         |                              |   | 18,879,464                   |      |   | 18,838,148 |   |   | 18,826,966 |   |

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**NESTOR,          INC.**

**NOTES          TO THE CONSOLIDATED FINANCIAL STATEMENTS**

| **Note                20-** | **Recent                accounting pronouncements:** |
|-----------------------------|------------------------------------------------------|

*“Accounting      for Uncertainty in Income Taxes”*
*“Accounting      for Income Taxes.”*

*“Fair      Value Measurements”*

| **Note                    21-** | **Subsequent                    Event:** |
|---------------------------------|------------------------------------------|

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| ITEM                9. | Changes                in and Disagreements with Accountants on Accounting and Financial                Disclosure |
|------------------------|--------------------------------------------------------------------------------------------------------------------|

| ITEM                9A. | Controls                and Procedures |
|-------------------------|----------------------------------------|

*Management’s      Report on Internal Control Over Financial Reporting*

| ITEM                9B. | Other                Information |
|-------------------------|----------------------------------|

| ITEM                10. | Directors,                Executive Officers and Corporate                Governance |
|-------------------------|--------------------------------------------------------------------------------------|

*Investor Information*

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| ITEM                  11. | Executive                  Compensation |
|---------------------------|-----------------------------------------|

| ITEM                12. | Security                Ownership of Certain Beneficial Owners and                Management |
|-------------------------|----------------------------------------------------------------------------------------------|

| ITEM                13. | Certain                Relationships Related Transactions and Director                Independence |
|-------------------------|----------------------------------------------------------------------------------------------------|

| ITEM                14. | Principal                Accountant Fees and Services |
|-------------------------|-------------------------------------------------------|

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**PART      IV**

| ITEM                15. | Exhibits,                Financial Statement Schedules. |
|-------------------------|---------------------------------------------------------|

|   | (1) | The                financial statements of the Company and accompanying notes, as set                forth                in the contents to the financial statements annexed hereto, are included                in Part                II, Item 8. |
|--------|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | (2) | Consolidated                Financial Statement Schedule: Valuation and Qualifying Accounts                and |
|--------|-----|----------------------------------------------------------------------------------------------------------------|

|   |   | Reserves.                All other schedules are omitted because such information is not                applicable. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------|

|   | (3) | Exhibits                numbered in accordance with Item 601 of Regulation S-K and filed                herewith. |
|--------|-----|-------------------------------------------------------------------------------------------------------------------|

|   | See                Exhibit Index. |
|--------|-----------------------------------|

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**PART      IV**

|                                          |   |  2006 |   |  2005 |   |  2004 |   |
|-----------------------------------------------|--------|------------|--------|------------|--------|------------|--------|
| Balance                  at beginning of year |   | $          | 164    |       | $      | 84         |   | $ | 84 |   |
| Provision                  charged to expense |   |       | 63     |       |   | 80         |   |   | 34 |   |
| Write-offs                  and recoveries    |   |       | ---    |       |   | ---        |   |   | (34 | ) |
| Balance                  at end of year       |   | $          | 227    |       | $      | 164        |   | $ | 84 |   |

|                                          |   |  2006 |   |  2005  |   |  2004  |   |
|-----------------------------------------------|--------|------------|--------|------------------|--------|------------------|--------|
| Balance                  at beginning of year |   | $          | 540    |             | $      | 50               |   | $ | --- |   |
| Provision                  charged to expense |   |       | 157    |             |   | 330              |   |   | 50 |   |
| Provision                  in other accounts  |   |       | ---    |             |   | 173              |   |   | --- |   |
| Write-offs                  and recoveries    |   |       | (155   | )                |   | (13              | )      |   | --- |   |
| Balance                  at end of year       |   | $          | 542    |             | $      | 540              |   | $ | 50 |   |

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**SIGNATURE**

|   | NESTOR,                    INC.                                |
|--------|----------------------------------------------------------------|
|   | (Registrant)                                                   |
|   |                                                           |
|   |                                                           |
|   | /s/                    William B. Danzell                      |
|   | William                    B. Danzell, Chief Executive Officer |
|   |                                                           |
|   |                                                           |
|   |                                                           |
|   | /s/                    Nigel P. Hebborn                        |
|   | Nigel                    P. Hebborn, Chief Financial Officer   |
|   |                                                           |
|   |                                                           |

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**INDEX        OF EXHIBITS**

| **Exhibit                      No.** | **Description                      of Exhibits** |
|--------------------------------------|--------------------------------------------------|

| 31.1 | Certification                    of principal executive officer pursuant to Rule 13a-14(a)/15d-14(a)                    of the                    Securities Exchange Act of 1934, as amended                    |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 | Certification                    of principal                    financial officer pursuant to Rule 13a-14(a)/15d-14(a) of the                    Securities                    Exchange Act of 1934, as amended |

|   |
|--------|
| *      | Certification                  is not deemed “filed” for purposes of Section 18 of the Exchange Act, or                  otherwise subject to the liability of that section. Such certification                  is                  not deemed to be incorporated by reference into any filing under                  the                  Securities Act or the Exchange Act, except to the extent that the                  registrant specifically incorporates it by                  reference. |

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