UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-K

   [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
        SECURITIES EXCHANGE ACT OF 1934

        For the period ended            December 31, 2004
                             -----------------------------------------

                             OR

   [ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
        OF THE SECURITIES EXCHANGE ACT OF 1934

        For the transition period from                    to
                                      -------------------    -------------------

                         Commission file Number 0-12965

                                  NESTOR, INC.
             (Exact name of registrant as specified in its charter)

                DELAWARE                                 13-3163744
      -----------------------------               ----------------------
         (State of incorporation)                    (I.R.S. Employer
                                                    Identification No.)

      400 Massasoit Avenue; Suite 200, East Providence, Rhode Island 02914
      --------------------------------------------------------------------
      (Address of principal executive offices)                  (Zip Code)

                                 (401) 434-5522
               --------------------------------------------------
              (Registrant's Telephone Number, Including Area Code)

           Securities registered pursuant to Section 12(b) of the Act:
                                      NONE

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.01 Par Value
                                (Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period than the  Registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.

                              Yes  X       No
                                 -----

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of Registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
            --------------------


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Indicate  by check mark  whether  the  Registrant  is an  accelerated  filer (as
defined in Rule 12b-2 of the Exchange Act).

                              Yes          No  X
                                             -----

The  aggregate  market  value of the  8,277,780  shares of voting  stock held by
non-affiliates of the registrant on June 30, 2004, based on the closing price of
such stock on June 30, 2004, was $33,856,120.

The number of shares  outstanding of the Registrant's  Common Stock at March 17,
2005 was 18,777,790.

                       DOCUMENTS INCORPORATED BY REFERENCE

Sections  of Nestor,  Inc.'s  definitive  Proxy  Statement  for the 2005  Annual
Meeting of Stockholders  are  incorporated by reference into Parts II and III of
this report.










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                                                                          PART I

ITEM 1.           Business
                  --------
GENERAL

Nestor, Inc., through its wholly owned subsidiary, Nestor Traffic Systems, Inc.,
is a leading provider of innovative,  video based traffic safety and enforcement
systems  to state  and local  governments  throughout  the  United  States.  Our
principal product,  CrossingGuard(R)  incorporates our patented image processing
technology  into an intelligent  turnkey  solution that predicts and records the
occurrence of a red light  violation,  and manages the entire process of issuing
and  processing  a  citation.   As  of  December  31,  2004,  we  had  installed
CrossingGuard  at 111 approaches for 13 customers  throughout the United States,
and our contracts  called for us to install  CrossingGuard  at an additional 128
approaches.  We offer an advanced mobile speed enforcement  product,  through an
agreement with a third party vendor which  provides us with exclusive  rights to
market  their  product  throughout  North  America.  We also offer  fixed  speed
enforcement solutions.

The  market  for   intelligent   transportation   systems  and   enforcement  is
experiencing  significant  growth,  particularly  in the area of  traffic  light
safety  enforcement.  There are an estimated 300,000  intersections (1.2 million
approaches)  with traffic  signals in the United  States.  Technology  solutions
manage  enforcement at less than 0.5% of these  approaches.  In 2002, as many as
207,000 crashes, 178,000 injuries and 921 fatalities in the U.S. were attributed
to red light  running.  Fifteen states and the District of Columbia have already
authorized or allow  municipalities  to elect the use of automated traffic light
systems,  such as  CrossingGuard;  more states are  currently  considering  such
legislation.

CrossingGuard is an automated,  video-based  monitoring system that predicts and
records the occurrence of a red light  violation.  If a violation is expected to
occur, the system can send a signal to the traffic controller to request a brief
extension  of the red phase for cross  traffic.  This helps  prevent  collisions
between  violators  and vehicles in the cross  traffic  accelerating  on a green
signal. The system  simultaneously  records the violation sequence,  including a
close-up  of the  vehicle  and  license  plate,  and  transmits  video  evidence
electronically to the police department,  which reviews the violation and issues
a citation.  We provide a complete turnkey solution,  offering violation review,
citation preparation and processing,  billing and collection,  court scheduling,
evidence,  and resolution.  Our advanced technology  captures  approximately 270
images of each violation,  enabling us to have an enforcement  rate in excess of
95%.  Depending  on the terms of each  contract,  we realize from $11 to $99 per
citation issued or paid or fixed monthly fees ranging from $2,000 to $12,000 per
approach for system delivery and lease,  maintenance,  software  licensing,  and
processing  services.  We believe that our strong suite of patents  covering our
image processing technology provides us with a strategic advantage and allows us
to offer a comprehensive solution to our state and local government clients.

In April 2004,  we signed a contract to provide and install our systems at up to
60  approaches in  Baltimore,  under a prime  contract that we believe to be the
largest  contract  awarded by a municipality to date. In March 2004, we signed a
contract  with the state of Delaware to provide and install our systems at up to
40 approaches. We believe that our contract with Delaware is the first automated
red light enforcement contract issued by a state to date.

Information about the industry segments and geographic areas in which we operate
can be found in Note 13 to the financial statements included in this report.

OUR STRENGTHS

We believe that we possess  many of the  attributes  that will be necessary  for
long-term success in our industry, including the following:

     o    TRAFFIC ENFORCEMENT  EXPERTISE.  We have provided traffic products and
          services to state and local  governments  for seven  years.  Given our
          expertise  and track  record with these  customers,  we believe we are
          well-positioned to take advantage of the expanding market and expected
          increase in spending for traffic safety activities.

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     o    SUBSTANTIAL INSTALLED CUSTOMER BASE AND CONTRACTS.  As of December 31,
          2004 we had long-term  contracts  with 13 customers and 111 approaches
          installed and generating  citations,  and an additional 128 approaches
          under contract, waiting for customer orders for delivery or in various
          stages of delivery.

     o    TECHNOLOGY AND INTELLECTUAL  PROPERTY  LEADERSHIP.  Through innovative
          use of pattern  recognition  technology,  we have produced a number of
          products to identify target patterns of information.  We have a strong
          patent   portfolio.   See  "--Patents."   With  our  team  of  veteran
          innovators,  we are focused and experienced in creating and protecting
          our intellectual property. We intend to continue to invest in research
          and  development  and product  engineering to enable us to continue to
          offer high quality,  differentiated and cost-effective products to our
          customers.   In  addition,   through  development,   distribution  and
          licensing agreements with third parties such as Vitronic, we intend to
          capitalize on leading  technologies  currently in the market and focus
          our  resources  on those  areas  that  provide  the most  value to our
          customers.

     o    PRODUCT   CAPABILITY.   We  believe   video-based   automated  traffic
          enforcement solutions are more technologically advanced than competing
          systems such as  in-ground  sensor loops and "wet film," or on digital
          still camera, red light camera systems.  We believe that our expertise
          in video-based  solutions is a competitive  advantage over many of our
          competitors.  We have a  proven  track  record  with  our  video-based
          traffic  enforcement  systems  performance  and  scalability  with our
          installed customer base.

     o    CUSTOMER  SERVICE  AND  SUPPORT.  We  believe  that our high  level of
          customer service and support  differentiates  us from our competitors.
          We offer our customers an array of product support services  including
          intersection analysis and evaluation,  user training, turnkey citation
          processing,  full system  maintenance  services,  toll-free  telephone
          numbers for customer  support and violator  inquiries  and  assistance
          with public education campaigns.

OUR STRATEGY

Our goal is to be the  leading  provider  of traffic  enforcement  products  and
services  to state and local  governments.  Our  strategy  is to  deliver to our
customers complete traffic enforcement solutions,  which are designed to enhance
safety  and  generate  sufficient  revenue to pay the costs of the  systems.  We
believe  that we  possess  many of the  attributes  that will be  necessary  for
long-term success in our industry by applying the following strategies:

     o    CAPITALIZE  ON  EMERGING  AUTOMATED  TRAFFIC  ENFORCEMENT  MARKET  AND
          INCREASE MARKET SHARE. We deliver complete  solutions to our customers
          and are  dedicated to being the industry  leader in automated  traffic
          enforcement products. We intend to continue to grow our installed base
          of approaches  as our primary  emphasis  through 2005.  Our key target
          customers  are  mid-sized and large  municipalities  with  significant
          traffic volume.  New legislation in many states has enabled  automated
          traffic  enforcement  and  increased  demand  for our  products.  As a
          result,  we have a significant  opportunity  to increase the number of
          state and local  government  clients we serve.  In particular,  we are
          seeing more municipalities seeking automated traffic enforcement,  and
          we  plan  to  initiate  new  relationships  and  expand  our  existing
          relationships  with  these  customers.  Currently,  more than  fifteen
          states'  legislatures  are  considering  bills  to  enable  or  expand
          automated traffic enforcement.  We believe that through our innovative
          technology   and   customer   service,   we  will   have   significant
          opportunities to new increase our number of approaches in newly opened
          geographic  markets  across the U.S. In  addition,  we believe that we
          will continue to grow our market share in our existing  markets as our
          customers  become more  comfortable and familiar with our products and
          services.

     o    SUPPORT  MARKET  DEVELOPMENT  EFFORTS.  We have  sought to  accelerate
          market  adoption  of our  automated  traffic  enforcement  products by
          participating  in the  legislative  process and in industry  standards
          committees.  We also  participate  in industry trade groups to broaden


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          acceptance and  understanding of the market. We seek to continue these
          efforts  to  grow  the  overall  market  opportunity.   We  intend  to
          accelerate  our  market  development   efforts  by  hiring  additional
          personnel in select  areas,  and  leveraging  the  relationships  that
          members of our management and our advisory  boards have with state and
          local governments.

     o    CONTINUE TO LEAD TECHNOLOGICAL INNOVATION. We intend to strengthen our
          position by continuing to make investments in research and development
          while leveraging and improving our patented  technologies.  We believe
          that  we have  been  able  to  capture  additional  market  share  due
          technological leadership with new products.

     o    LEVERAGE CUSTOMER  RELATIONSHIPS TO EXPAND PRODUCT LINE. We believe we
          will have significant  opportunities to leverage our existing customer
          relationships into other areas of automated traffic enforcement,  such
          as automated speed enforcement.

     o    EXPAND  AND  DEEPEN   RELATIONSHIPS  WITH  CUSTOMERS.   We  intend  to
          strengthen  and broaden  the scope of our  customer  relationships  by
          expanding our customer  support  services to become an integrated part
          of our  customers'  traffic  enforcement  solution.  To implement this
          strategy,  we  intend  to  continue  to  collaborate  with  our  major
          customers at the design and  development  stage of new products and to
          seek to add value to our traffic systems.

     o    CONTINUE TO PURSUE SELECT  ALLIANCES,  OPPORTUNISTIC  ACQUISITIONS AND
          INVESTMENTS.  We will  continue to  evaluate  and  selectively  pursue
          strategic alliances,  opportunistic  acquisitions and investments that
          are   complementary  to  our  business.   We  will  continue  to  seek
          opportunities that provide us with enhanced  technological  expertise,
          new markets for our products, a stronger product portfolio,  increased
          market share, new products or a diversification of risk.

     o    MAINTAIN  STABLE CASH FLOWS FROM  OPERATIONS AND  DISCIPLINED  CAPITAL
          SPENDING.  Our automated  traffic  enforcement  systems are sold under
          long-term  contracts  that provide  visibility on our future sales and
          cash flow.  We intend to maintain our  financial  performance  through
          continued  productivity  initiatives  designed to sustain our margins,
          reduce  costs  and  improve   operating   efficiency   throughout  our
          businesses.   We  make  disciplined  capital  expenditure   decisions,
          prioritized on the basis of cost structure improvement,  potential for
          profit generation and maintenance of high quality service.

COMPANY HISTORY

We were  incorporated in 1983. We have engaged in various  businesses  since our
incorporation.  Today,  our  business  is limited to  providing  and  installing
CrossingGuard  systems  and  Vitronic  speed  enforcement  products,  processing
citations produced by those systems and related services.

Significant events in our recent corporate  history,  some of which are referred
to elsewhere in this annual report, are listed here:

     o    CHANGE IN CONTROL.  On January 15, 2003,  Silver Star  Partners I, LLC
          purchased  49 million  shares of our  pre-reverse  stock split  common
          stock  for  $2,376,500  and on  April  16,  2003,  completed  a second
          closing,  purchasing  4,013,557  post-reverse  stock split  shares for
          $1,946,575.  William B. Danzell,  our Chairman,  President and CEO, is
          the Managing  Director of Silver Star.  Upon  completion of the second
          closing,  Silver  Star owned 64% of our  outstanding  shares of common
          stock.

     o    REVERSE STOCK SPLIT.  We amended our certificate of  incorporation  on
          April 11,  2003,  reverse  splitting  our common stock one for ten. We
          issued  one share of our  common  stock  after the split for every ten
          shares outstanding before the split.

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<PAGE>


     o    MERGER OF NESTOR  TRAFFIC  SYSTEMS.  In January 1997, we organized two
          wholly-owned  subsidiaries,  Nestor Traffic  Systems,  Inc. and Nestor
          Interactive,  Inc. In November 1998, we ceased  further  investment in
          Nestor  Interactive.  In 1999,  Nestor Traffic Systems sold a majority
          common stock  interest to a group of investors.  In June 2000,  Nestor
          Traffic Systems sold additional  shares of its common stock to private
          investors and our ownership of Nestor  Traffic  Systems was diluted to
          approximately  35%. On September 12, 2001,  we merged  Nestor  Traffic
          Systems, Inc. into our wholly-owned subsidiary, which was then renamed
          Nestor Traffic Systems, Inc.

     o    APPLIED  COMMUNICATIONS,  INC. On February 1, 2001,  we entered into a
          non-exclusive license agreement with Applied  Communications,  Inc. We
          granted Applied  Communications  the right to integrate and distribute
          all of fraud  detection  products  throughout its worldwide  sales and
          support network.  Applied  Communications paid us $1.1 million in four
          equal  installments  in the first six months of 2001, and was required
          to make guaranteed  minimum royalty  payments during the first year in
          an amount of approximately  $500,000. The license requires the payment
          of a 15%  royalty  starting  on  February  1,  2002,  but  no  further
          guaranteed  minimum  royalty  payments are  required.  This  agreement
          replaced  an earlier  license to Applied  Communications.  We sold the
          royalty rights to Churchill Lane  Associates from this license on July
          1,  2002.  We do not  expect  to  receive  future  revenues  from this
          license.

     o    RETAIL  DECISIONS,  INC. On May 18,  2001,  we entered  into a license
          agreement with Retail  Decisions,  Inc. We granted Retail  Decisions a
          perpetual,  fully-paid, worldwide license in the field of use of fraud
          and money laundering  detection and risk management in certain defined
          industries;  and a  non-exclusive,  perpetual,  fully-paid,  worldwide
          license  solely for use in the field of use of  customer  relationship
          management in certain  defined  industries.  Retail  Decisions paid us
          $1,800,000 under the license agreement,  and for certain marketing and
          transition  services,  we paid Retail  Decisions  $968,000 in 2001. No
          ongoing revenues are expected to be realized from Retail Decisions.

     o    NATIONAL  COMPUTER  SYSTEMS,  INC. On June 11, 1996, we entered into a
          licensing  agreement and an asset  purchase  agreement to transfer the
          development,   production,  and  marketing  rights  of  our  character
          recognition  products to National Computer Systems.  National Computer
          Systems  continues  to market the products on a  non-exclusive  basis.
          Historically,  we  have  received  approximately  $25,000  in  minimum
          royalties per year under this license.


INDUSTRY OVERVIEW

STATUS OF THE CROSSINGGUARD MARKET.  Ineffective red-light safety enforcement is
a costly and growing problem that until recently has been largely unaddressed by
technology solutions.  There are an estimated 300,000 intersections with traffic
signals in the United States where, in 2000,  there were  approximately  106,000
red light  running  crashes that  resulted in 89,000  injuries and 1,036 deaths,
according to the Federal  Highway  Administration.  In 2002,  as many as 207,000
crashes,  178,000 injuries and 921 fatalities in the U.S. were attributed to red
light  running,  according to the National  Campaign to Stop Red Light  Running.
First-generation  red-light camera systems gained early acceptance as a means of
automated  traffic  enforcement.  Although  these  systems  validated the market
opportunity,  they generally continue to rely on in-ground vehicle sensing loops
and still  photography and have become inferior  solutions  because of their (i)
significant roadbed installation issues, (ii) high maintenance requirements, and
(iii) general lack of functionality.

The use of cameras to enforce red light  running  violations  requires  specific
authority at the state or local government level,  either through state enabling
statutes  or home  rule  statutes.  To date,  approximately  15  states  and the
District of Columbia  authorize on a full or limited  basis the use of red light
cameras. States allowing red light enforcement include:
         Arizona             Illinois                Ohio
         California          Iowa                    Oregon
         Colorado            Maryland                South Dakota
         Delaware            New York                Tennessee
         Georgia             North Carolina          Washington

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Recent  studies  have shown these  systems to be effective in reducing red light
running at enforced  intersections,  and a positive  halo effect at  surrounding
unenforced   intersections.   The  Federal  Highway   Administration  and  other
organizations have recently  acknowledged these systems as positive tools in the
reduction  of red light  running and  correspondingly  the number of  accidents.
According  to the  Federal  Highway  Administration,  a  1998  Lou  Harris  poll
sponsored  by  Advocates  for Highway & Auto Safety  found that 65% of Americans
favored  adoption of  legislation  to allow use of red light  cameras.  However,
there remains opposition to these systems, largely based upon concerns regarding
individual  privacy rights and due process  rights.  Many states and communities
have or are  considering  authorization  of cameras  but need to  address  these
minority  concerns first. We believe that the overall trend is towards  expanded
state  authorization  of  camera  based  red  light  enforcement   systems,  and
eventually speed enforcement systems, but it is difficult to estimate when these
changes  may  occur.  We also  believe  that  business  opportunities  from  the
currently  authorized  communities  will be enough to support  near term  growth
objectives.

PRODUCTS AND SERVICES

Our products combine  sophisticated  digital and analog camera technologies with
advanced   image   processing   to  detect  and   interpret   a  wide  range  of
traffic-related  elements and  conditions.  Our products  are a  combination  of
Nestor-developed   software  and  modular   hardware   components  that  provide
monitoring for traffic-data  collection,  control of traffic flows,  enforcement
and  emergency  response.  Our products are flexible and can be  configured to a
wide range of road configurations,  including open roads and intersections.  Our
systems  offer  an array of  features  and  unique  functionality  that  address
critical  transportation  management  and  traffic  safety  needs.  We  formerly
developed  and  marketed  products  in the fields of risk  management,  customer
relationship management and character recognition.

CROSSINGGUARD RED LIGHT ENFORCEMENT

Our  CrossingGuard  systems use high speed image processing and  target-tracking
technology  applied to  real-time  video  scenes.  The products use software and
video  cameras to detect red light  violators  at  signalized  intersections  by
combining  sophisticated  digital and analog video  technologies  with  advanced
image  processing  to  detect  and  interpret  a wide  range of  traffic-related
elements and conditions. Using the captured video images, we apply algorithms to
recognize  objects as vehicles  and predict  their  motion  relative to the stop
line. This advanced  technology,  which effectively sees and interprets  objects
captured in video images, is at the core of the CrossingGuard solution.

CROSSINGGUARD(R).  CrossingGuard is an automated,  video-based monitoring system
that predicts and records the occurrence of a red light violation. The software,
through a video camera,  tracks vehicles  approaching an intersection.  Based on
the  vehicle's  speed,  acceleration,  and distance from the  intersection,  the
system  predicts  whether a red light  violation  will occur.  If a violation is
expected  to occur,  the system can send a signal to the traffic  controller  to
request a brief extension of the red phase for cross traffic. This helps prevent
a collision between the violator and vehicles in the cross traffic  accelerating
on a green signal.  The system  simultaneously  records the violation  sequence,
including  a close-up of the vehicle and  license  plate,  and  transmits  video
evidence  electronically to the police  department,  which reviews the violation
and  issues a  citation.  We  provide  citation  mailing  and other  back-office
services.

We provide a complete turnkey  solution,  offering  violation  review,  citation
preparation and processing, billing and collection, court scheduling,  evidence,
and resolution.  In addition,  we provide direct,  remote,  and online equipment
monitoring and maintenance  primarily through its field and office personnel and
through local contractors as necessary.

The  CrossingGuard  system  consists  of a video  camera  installed  on top of a
traffic  signal pole or a roadside pole installed by the Company that is used to
track  approaching  vehicles and record the actions of an approaching  violator.
Another  camera is positioned so as to see the signal lights as they change from
green to yellow to red and record the vehicle's actions as the lights change and
it enters  the  intersection.  The views  from  these  two  cameras  can also be
presented in a side-by-side  synchronized  mode to demonstrate the complete view
of the violation,  including extenuating circumstances,  aggressive behavior, or
other factors. Finally, an enforcement camera is positioned to obtain a close-up
image of the vehicle  license  plate,  and where needed the driver image,  based
upon vehicle location  instructions  provided by the tracking camera. A personal


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computer  runs the  intelligent  software  and controls  camera  activity and is
installed in an enclosure by the wayside or fiber  connection to the roadside is
used. High-speed communications transmit video and data from the intersection to
a  designated  facility  for  processing.   The  facility  is  equipped  with  a
CrossingGuard  Server PC that  receives and stores  violation  data and supports
authorized viewing of violation video sequences.

CrossingGuard is built upon standard PC hardware and software  components.  This
design  provides  the  reliability  and  performance  benefits of  improving  PC
hardware and the ability to upgrade and add functionality as needed. We purchase
all  electronic  and mechanical  components  from third party vendors,  built in
accordance with our specifications, and local contractors install the systems.

The primary attributes of CrossingGuard are:

     o    ACCURATE,  REAL-TIME  INTERPRETATION  OF TRAFFIC VIDEO IMAGES. We have
          applied our high-speed  pattern-recognition  technologies in real-time
          processing  and  video-image  interpretation  for traffic  management,
          enforcement and safety. Prior industry attempts to provide video-based
          detection of traffic have not proven  effective due to the  difficulty
          of  designing   robust   detection   algorithms  under  a  variety  of
          illumination,  visibility and traffic conditions,  as well as the need
          to implement such  algorithms on  cost-effective  computing  platforms
          that provide real-time operation.  Our image-understanding  technology
          is  able  to  interpret  video  images  accurately  and  respond  in a
          real-time environment at affordable cost.

     o    VEHICLE TRAJECTORY ANALYSIS FOR REAL-TIME  FORECASTING.  As each frame
          in a video  sequence is  interpreted,  the  individual  objects in the
          scene are identified and located. This information,  passed from frame
          to frame, enables accurate tracing of vehicles'  trajectories.  Unlike
          competitive vision systems,  which note changing images in a fixed and
          static area of the image  (so-called  virtual loops),  our proprietary
          vehicle-centric technology can use the trajectories to predict vehicle
          positions. In the CrossingGuard  application,  when a vehicle is about
          to run a red  light,  a  signal  can  then  be  sent  to  the  traffic
          controller to extend the all-red  phase of the traffic  signal so that
          cross traffic vehicles can be briefly delayed before they proceed into
          the intersection. Thus, intersections equipped with CrossingGuard have
          the potential to become smarter and safer.

     o    COMPATIBILITY WITH INDUSTRY STANDARD PLATFORMS. Our traffic monitoring
          solutions are built upon dominant industry-standard platforms: namely,
          Microsoft   Windows   operating   systems,   tools  and  communication
          components  and  general  "WinTel"   hardware   specifications.   This
          facilitates   integration   into  a  customer's   existing   computing
          environment,   leverages   PC   economics   to   offer  a   compelling
          price/performance advantage and lowers product engineering development
          costs.  Additionally,  the traffic  monitoring systems are designed to
          support the emerging NTCIP communications  standards being mandated in
          the traffic  industry.


We also provide services related to our CrossingGuard systems:

CROSSINGGUARD VIP. The CrossingGuard Video Intersection  Profiling (VIP) program
is a proprietary tool that we have developed to help municipalities  pre-qualify
intersections. Since intersection violation rates can range from an average of a
few per day to over fifty per hour, the system helps the municipality develop an
estimate  of safety  issues at a given  intersection  and the  long-term  ticket
volume by counting and profiling  violations  for all directions at a particular
intersection.


CROSSINGGUARD  SERVICES.  CrossingGuard  Services  is the  complete  package  of
services and support that can be customized to a client's  needs. It consists of
site planning and equipment installation,  equipment maintenance,  user training
and  support,  violation  review,  citation  preparation  and  processing,  fine
collection and processing, account management, toll free hotline support, public
education, and expert testimony.

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The economics of the CrossingGuard  product are tied to the number of violations
processed by the systems and the number of operating  systems in the field. Many
contracts  compensate us on a per ticket paid or issued basis in return for both
equipment lease, maintenance and back office services. Generally, but not in all
cases,  the  contracts  require a monthly  minimum  fee  designed to allow us to
recover  the value of the  system  delivered,  including  a finance  factor  and
maintenance  costs,  over the term of the  contract.  Throughout  2003 and 2004,
there  has been a trend by  states  towards  fixed  monthly  fee as  opposed  to
variable per ticket fee pricing structures.

As of  December  31,  2004,  we had  111  approaches  installed  and  generating
citations and an additional 128 approaches under contract,  waiting for customer
orders for delivery or in various stages of delivery. No assurances can be given
that all approaches under contract will ultimately be installed.  Depending upon
contract  terms, we realize from $11 to $99 per citation issued or paid or fixed
monthly fees ranging from $2,000 to $12,000 per approach for system delivery and
lease, maintenance,  software licensing, and processing services. State statutes
providing for automated red light enforcement may impose liability on the driver
or the registered owner of a vehicle for a violation.  Driver liability statutes
require that the driver be identified,  from the photographic evidence, and that
the citation be issued and sent to the driver. Registered owner statutes require
that the vehicle's owner be identified,  through registration  records, and that
the  citation  be issued and sent to the driver.  As only the  license  plate is
required for identification under a registered owner statute,  program operating
efficiencies  are much higher  resulting in lower per citation or monthly  fees.
Current  trends in the  industry  are  towards  compensating  red-light  program
vendors  on a fixed fee basis  instead  of a  variable  fee basis tied to ticket
volumes. Actual results from deployment of CrossingGuard systems are expected to
fluctuate substantially depending upon intersection selection and configuration,
driver response to installed  systems,  and many other factors.


SPEED PRODUCTS

In August 2004, we entered into an exclusive distributorship agreement with a US
subsidiary of Vitronic GmbH, a German based corporation that provides  solutions
for factory and industrial automation, quality inspection, logistics and traffic
management systems.  Under the terms of the agreement,  we have exclusive rights
to market  and sell  Vitronic's  PoliScan  Speed  Mobile  throughout  the United
States,  Canada,  and  Mexico,  for an initial  term of five  years,  subject to
minimum annual sales goals.

PoliScan Speed Mobile is a system for digital speed detection and recording.  In
contrast  to  conventional   measures  such  as  radar,   light  barriers,   and
piezo-section,  a complex  installation  and  calibration  of the  system at the
measurement  site is not  necessary.  An  additional  feature is the  ability to
simultaneously  record and measure  several  vehicles in  parallel  lanes.  Thus
ambiguities and measurement  errors can be reliably  avoided.  The system uses a
high-resolution  digital  camera  for  documentation  of the  speeding  offense,
including  pictures of the license plate,  an overview  picture,  as well as the
image of the driver where required.

We offer a fixed  site  speed  camera  system.  The system  will  deliver  video
evidence of vehicles speeding with advanced nonintrusive, performance similar to
our CrossingGuard  systems. It is designed to allow for upgrading  CrossingGuard
installations to enable dual 'red-and-speed' intersection monitoring. The system
may also be installed on a standalone  basis.  Our fixed speed solution uses two
independent  speed detection sensors to  cross-reference  and verify the vehicle
speed, a feature that we believe is unique to our product.

We have begun  marketing our speed  products to  jurisdictions  in the
United States that allow the automated enforcement of speed limits.

OTHER TRAFFIC PRODUCTS

We have two other traffic safety and enforcement  products - Rail  CrossingGuard
and  TrafficVision.  We are no longer marketing or developing these products and
we do not expect to receive material  revenue related to them in the future.  In
2002 we  eliminated  our  marketing and sales efforts for these product lines to
focus our resources on the CrossingGuard red-light enforcement market.

                                       9
<PAGE>

RAIL  CROSSINGGUARD.  We  developed  Rail  CrossingGuard,  a system  to  monitor
grade-crossing vehicle and train traffic, as well as signalization  activity, to
provide   grade-crossing-integrity   measurement,   real-time   crossing   alert
capabilities and crossing violation enforcement.  This product has the potential
to  enhance   rail-crossing   safety  by  improving  signal  and  crossing  gate
monitoring,  alerting personnel to dangerous crossing situations,  and enforcing
train and vehicle safety regulations.  Rail CrossingGuard may also be integrated
with train  communications  systems to  provide a method of  alerting  trains to
dangerous rail crossing conditions.

TRAFFICVISION.  TrafficVision  is a product  that uses video  cameras to monitor
traffic flow and to send traffic data to a central  Traffic  Operations  Center.
Replacing short-life,  high-maintenance,  road-embedded copper-loop technologies
from the 1950's,  TrafficVision  is a  non-intrusive  sensor  system for traffic
management.  TrafficVision  uses  our  proprietary  high-speed  image-processing
technology to analyze  video  content to sense and monitor  traffic on highways,
roadways and intersections in real-time. TrafficVision recognizes and classifies
multiple vehicles  continuously so that surveillance and traffic  management are
based upon detailed,  real-time  information.  TrafficVision  is installed at 26
locations  in Rhode  Island and in the state's  centralized  Traffic  Operations
Center in Providence.

SALES, MARKETING AND METHODS OF DISTRIBUTION

We market our  products  and services to  municipalities,  governmental  traffic
management departments, or their integrators through our nationwide direct sales
force.  Because our products require  technical  assistance during the sales and
installation  processes,  we also maintain an in-house staff of program managers
and  field  engineers.  We  obtain  product  inquiries  from  product  mailings,
attendance  at trade shows,  trade press  coverage and our Internet  site.  Most
CrossingGuard  contracts are obtained through competitive  proposal processes in
response to requests for proposals issued by  municipalities.  We subscribe to a
service  that advises us of relevant  requests for proposal  issued by state and
local  governments.  In 2004, we submitted  fifteen proposals to state and local
governments.  In 2004,  as a result of bids  submitted in 2003 and 2004, we were
awarded  three  contracts  and we have been selected as the provider by, but not
entered into a contract with, six municipalities.  No provider has been selected
with  respect to five of the  requests  for  proposals  to which we responded in
2004.

RESEARCH AND DEVELOPMENT ACTIVITIES

The focus of our research and development is to develop and improve our products
and  technologies  in order to maintain  and improve our  products'  competitive
advantages,  our level of customer  service and satisfaction and to consider the
development of new technologies  and products.  We have pursued new and enhanced
technologies  and  products  extensively  in the past and may do so again in the
future,  but our  current  emphasis  is on  developing  and  improving  existing
products with a proven market.

Our research  and  development  includes  applied  research  intended to develop
solutions to specific  pattern-recognition  problems. This research has resulted
in various  patents and patents  pending  relating to  improvements to our basic
technology.  See "--Patents." We have two additional patent applications pending
as of December 31, 2004, both in the area of traffic management, enforcement and
safety.

Changing  technologies may affect the market for our products.  Our success will
depend upon its ability to maintain and enhance its current products and develop
new products in a timely and  cost-effective  manner that meets changing  market
conditions. There can be no assurance that we will be able to develop and market
on a timely basis, if at all, product  enhancements or new products that respond
to changing market conditions or that will be accepted by customers. Any failure
by us to anticipate or to respond adequately to changing market  conditions,  or
any  significant  delays in product  development  or  introduction  could have a
material  adverse  effect on our  business,  financial  condition and results of
operations.

We spent $157,000, $121,000 and $1,604,000 in the years ended December 31, 2004,
2003 and 2002 respectively, on research and development.

                                       10
<PAGE>


PATENTS

We have continually sought and obtained patent protection for our traffic safety
systems and for our  proprietary  neural  networks as, which have as a principal
feature  rapid  learning  from a  relatively  small  number of  examples  or the
application of video techniques in traffic management applications. Our patented
neural network  exhibits  rapid learning and minimizes the internal  connections
needed  for its  functioning.  We  believe  that  these  capabilities  make  our
technology  uniquely suited to applications  that require field  trainability or
self-modification  to adapt to new or changing patterns in the data. Our patents
also cover multiple-neural-network systems, which enabled us to develop products
that combined high accuracy with high processing speeds.

During 2004, we received two additional  patents  relative to the  CrossingGuard
product line. The first patent  recognizes the  transmission of video as part of
the user interface in our  CitationComposer  software for ticket  processing and
issuance. The second patent recognizes the invention of a traffic sensor.

During 2003, we received two additional  patents  relative to the  CrossingGuard
product line.  One of those  patents  recognizes  our method of  predicting  and
recording a red light violation with a video-based  system  including the use of
violation  probability  scores. The second patent defines a system and method of
detecting and filtering  non-violations  in a traffic light  enforcement  system
employing a video camera to improve the  effectiveness of the system.  We own 13
United States patents and 14 foreign  patents.  We have one pending U.S.  patent
application  and three  foreign  patent  applications  pending.  Six of our U.S.
patents,  two of our  foreign  patents and all of our patent  applications  have
relevance to our traffic safety business.  The foreign patents correspond to one
or more of the United  States  patents.  The  United  States  patents  expire at
various times from 2006 to 2021.

COMPETITION

We  believe  that  CrossingGuard  is more  technologically  advanced  than  most
competing  systems for traffic safety  enforcement.  Its  competition  generally
consists of "wet film" or digital  still image red light camera  systems.  These
systems  generally  rely on wet film or digital still cameras that record only a
few frames of evidence  regarding  a  violation,  and  in-ground  sensor  loops.
In-ground  sensor  loops  require  digging  up the  pavement  and are  generally
unresponsive  to  vehicles  moving  below  twelve  miles per hour.  For wet film
systems,  there is the added burden of retrieving,  replacing,  developing,  and
scanning the film. By the end of 2003, most competitors  have developed  digital
still systems and do not promote wet film applications.

CrossingGuard  vehicle detection cameras, on the other hand, are installed above
the ground, on roadside poles or if needed, mast arms. (This helps avoid some of
the logistical  problems  associated  with  installing  in-ground  sensors at an
intersection.)  In case of a dispute,  unlike non-video  systems,  the violation
video  sequence has the ability to provide an instant  replay of the event.  Its
digital  video  evidence  consists of both front and rear vehicle  images and is
viewed by the police who then issue (or give authorization to issue) a citation.
This ensures fairness so that violations may not be issued out of context (e.g.,
if the  violation  occurred to make way for an emergency  vehicle,  as part of a
funeral procession,  or to avoid a crash). This perception of fairness makes our
video evidence attractive to city councils, law enforcement  officials,  courts,
and the general public. Our systems have a high enforceability  rate; we average
99% in registered  owner  liability  jurisdictions  and 95% in driver  liability
jurisdiction.   The  enforceability  rate  is  the  ratio  of  not  successfully
challenged to citations  issued.  We believe that our  enforceability  rates are
higher than those of our many of our competitors and that part of the reason for
our high rate is the perception of fairness.  Because of the ability to view the
violation video sequence, violators find it difficult to challenge our citations
based on context.

We are aware of at least six  competitors  that  purport  to have video in their
systems.  We have initiated  patent  infringement  lawsuits against two of these
competitors  on the basis of our February 13, 2001 patent  entitled  "Integrated
Traffic Light Violation  Citation  Generation and Court Date Scheduling  System"
and,  with  respect to one of those  competitors,  on our June 22,  2004  patent
entitled   "Video-file  based  citation  generation  system  for  traffic  light
violations."  See  "Risk  Factors  --If We  Fail To  Protect  And  Preserve  Our
Intellectual  Property, We May Lose An Important Competitive  Advantage" and "--
Legal  Proceedings."  There can be no assurance  that we will be  successful  in
defending  this patent and limiting the use of video by  competitors in the U.S.
red light enforcement market.

                                       11
<PAGE>


Our largest  competitors  in the  intersection  market are  Affiliated  Computer
Services,  Inc. (ACS), which has the greatest number of red-light camera systems
installed,  and Redflex Traffic Systems, Inc. (Redflex).  Among others are Laser
Craft, Mulvihill ICS, Peek Traffic, Poltech, Traffipax,  Transol, and Transcore.
Although these  companies use buried loops,  still or digital cameras and/or wet
film  systems,  some may pose a  competitive  threat due to their  size,  market
share, legacy customer relationships, enhanced driver image, additional products
offered, and/or citation-processing experience.

Most of our competitors  have  significantly  greater  financial,  marketing and
other  resources  than we do.  As a  result,  they may be able to  respond  more
quickly to new or emerging  technologies  or to devote greater  resources to the
development,  promotion  and sale of  their  products  than we may.  Competitive
pressures faced by us may materially  adversely  affect its business,  financial
condition and results of operations.

CONTRACTS WITH GOVERNMENTAL ENTITIES

Our  CrossingGuard  agreements  are generally  service  contracts with states or
municipalities  that in most  circumstances may be cancelled by the customer for
various reasons.  As these contracts are generally  self-funded from ticket fees
collected from red-light  violators and some contracts  contain  termination fee
provisions,  we do not expect this to be a significant  risk in the future.  Our
Rail  CrossingGuard  and  TrafficVision   contracts  were  generally   fixed-fee
deliverable   contracts  and  termination   rights  were  generally  limited  to
non-performance  conditions.  We retain all patent and other proprietary  rights
from products developed and delivered under government-supported contracts.

EMPLOYEES

As of  December  31,  2004,  we had 65  full-time  employees,  comprising  16 in
software  engineering  and  product  development,  11 in  processing  and system
support,  25 in program management and field services,  7 in sales and marketing
and 6 in  management,  finance  and office  support.  All of our  employees  are
located in the United States.  None of our employees are  represented by a labor
union.  We have  experienced  no work  stoppages  and  management  believes  our
employee relationships are generally good.

                    RISK FACTORS THAT MAY AFFECT OUR RESULTS

This Annual  Report on Form 10-K and  certain  other  communications  made by us
contain  forward-looking  statements,  including statements about our growth and
future  operating  results,  discovery and  development  of products,  strategic
alliances and intellectual property. For this purpose, any statement that is not
a statement of historical fact should be considered a forward-looking statement.
We often use the words  "believe,"  "anticipate,"  "plan,"  "expect,"  "intend,"
"will" and similar  expressions  to help  identify  forward-looking  statements.
References in this exhibit  "we," "us," and "our" refer to Nestor,  Inc. and its
subsidiaries.

We cannot assure investors that our assumptions and  expectations  will prove to
have been correct.  Important  factors could cause our actual  results to differ
materially from those indicated or implied by forward-looking  statements.  Such
factors that could cause or contribute to such differences include those factors
discussed below. We undertake no intention or obligation to update or revise any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.

RISKS RELATED TO OUR BUSINESS

WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE

We have a history of net losses.  For the years ended  December 31, 2004,  2003,
2002,  2001  and  2000,  our net  losses  have  been  approximately  $4,473,000,
$4,890,000, $12,634,000,  $1,565,000, $2,995,000 and $837,000, respectively. For
the three-month  period ended December 31, 2004, our net loss was  approximately
$1,959,000.  We expect to incur continuing losses for the foreseeable future due
to  significant  engineering,   product  delivery,  marketing  and  general  and
administrative  expenses,  which  losses could be  substantial.  We will need to
generate significantly higher revenue to achieve profitability,  which we may be
unable to do. Even if we do achieve profitability, we may not be able to sustain
or increase our profitability in the future.

                                       12
<PAGE>

ALMOST ALL OF OUR CURRENT REVENUE IS FROM A SINGLE PRODUCT AND RELATED SERVICES

Currently, almost all of our revenue is from sales of our CrossingGuard systems,
services  related  to  installing  and  maintaining   CrossingGuard  systems  or
processing citations issued by CrossingGuard  systems. There can be no assurance
that we will be able to develop other  sources of revenue.  Because our revenues
depend  on  a  single  product,  any  decrease  in  the  market  share  held  by
CrossingGuard  would  have a  substantial  adverse  effect on our  business  and
financial  results.  If we fail to meet our expectations for the growth in sales
of CrossingGuard  or if we are not able to develop other sources of revenue,  we
will not be able to generate the significantly higher revenue that we believe we
must generate to achieve profitability.

OUR FINANCIAL  CONDITION AND RESULTS OF OPERATIONS MAY BE ADVERSELY  AFFECTED IF
WE ARE UNABLE TO SECURE AND MAINTAIN FUTURE CONTRACTS WITH GOVERNMENT AGENCIES

Contracts with  government  agencies  account for  substantially  all of our net
revenues. The majority of these contracts may be terminated at any time on short
notice with limited penalties.  Accordingly, we might fail to derive any revenue
from sales to  government  agencies in any given future  period.  If  government
agencies  fail to renew or if they  terminate any of these  contracts,  it would
adversely  affect our business and results of operations.  In addition,  many of
our contracts do not allow  installations  until sites have been approved by the
contracting  agency;  in those cases,  if a  government  agency fails to approve
sites, we will not be able to deliver products and services.

WE FACE SUBSTANTIAL COMPETITION,  WHICH MAY RESULT IN OTHERS DEVELOPING PRODUCTS
AND SERVICES MORE SUCCESSFULLY THAN WE DO

Many other companies offer products that directly compete with CrossingGuard and
our  other  products.  Many  of  our  current  and  potential  competitors  have
significantly  greater  financial,  marketing,  technical and other  competitive
resources than we do and may be able bring new  technologies to market before we
are able to do so.  Some of our  competitors  may have a  competitive  advantage
because of their size,  market share,  legacy customer  relationships,  enhanced
driver  imaging,   additional   products   offered  and/or   citation-processing
experience.   Current  and  potential   competitors  may  establish  cooperative
relationships with one another or with third parties to compete more effectively
against us. One of our  competitors,  ACS,  offers  state and local  governments
solutions to a wide variety of data processing issues and may have a competitive
advantage  because  of the scope of its  relationship  with,  and the  volume of
transactions it conducts for, a particular government.  It is also possible that
new competitors may emerge and acquire market share. If we are not successful in
protecting  our patents,  we would lose a competitive  advantage.  See "-- If We
Fail To Protect And Preserve Our Intellectual Property, We May Lose An Important
Competitive Advantage."

THE FAILURE OF GOVERNMENTS TO AUTHORIZE AUTOMATED TRAFFIC SAFETY ENFORCEMENT MAY
HINDER OUR GROWTH AND HARM OUR BUSINESS

Approximately  fifteen states and the District of Columbia authorize some use of
automated red light enforcement or allow  municipalities to elect to do so under
home rule laws. It is uncertain at this time which  additional  states,  if any,
will  authorize the use of automated red light  enforcement  or if there will be
other changes in the states that  currently  allow the  practice.  If additional
states  do not  authorize  the  use of  automated  red  light  enforcement,  our
opportunities  to generate  additional  revenue  from the sale of  CrossingGuard
systems and related  services will be limited.  Recently,  the Virginia  General
Assembly  declined to extend  authorization  for automated red light enforcement
beyond the sunset date of June 30, 2005 in the enabling legislation.

We could be subject to differing  and  inconsistent  laws and  regulations  with
respect to  CrossingGuard.  If that were to happen,  we may find it necessary to
eliminate,  modify or cancel  components  of our  services  that could result in
additional development costs and the possible loss of revenue. We cannot predict
whether future  legislative  changes or other changes in the eighteen  states or
other states, in the administration of traffic enforcement  programs,  will have
an adverse effect on our business.

                                       13
<PAGE>


The market for automated speed enforcement products in the United States is very
limited.  At least five states and the  District of  Columbia  have  legislation
authorizing some use of automated speed  enforcement or allow  municipalities to
elect to do so under home rule laws.  Some of these states  authorize  automated
speed enforcement only in limited circumstances such as school or work zones. If
additional   states  do  not  authorize   automated   speed   enforcement,   our
opportunities  to generate  additional  revenue from the sale of automated speed
enforcement systems and related services will be limited.

OUR FINANCIAL  RESULTS WILL DEPEND  SIGNIFICANTLY  ON OUR ABILITY TO CONTINUALLY
DEVELOP OUR PRODUCTS AND TECHNOLOGIES

The markets for which our products and  technologies  are designed are intensely
competitive and are characterized by short product lifecycles,  rapidly changing
technology  and  evolving  industry  standards.   As  a  result,  our  financial
performance  will depend to a significant  extent on our ability to successfully
develop and enhance our products.  Because of the rapidly changing  technologies
in the businesses in which we operate, we believe that significant  expenditures
for research and development and engineering will continue to be required in the
future.  To succeed in these  businesses,  we must  anticipate  the features and
functionality  that  customers  will  demand.  We must  then  incorporate  those
features and  functionality  into products that meet the design  requirements of
our customers.  The success of our product  introductions will depend on several
factors, including:

     o    proper product definition;

     o    timely completion and introduction of enhanced product designs;

     o    the  ability  of   subcontractors   and  component   manufacturers  to
          effectively  design and implement the  manufacture  of new or enhanced
          products and technologies;

     o    the quality of our products and technologies;

     o    product  and  technology   performance  as  compared  to  competitors'
          products and technologies;

     o    market acceptance of our products; and

     o    competitive pricing of products, services and technologies.

We must successfully  identify product and service opportunities and develop and
bring our products and technologies to market in a timely manner. We have in the
past experienced delays in completing the development or the introduction of new
products.  Our failure to  successfully  develop and  introduce  new or enhanced
products and technologies or to achieve market  acceptance for such products and
technologies may materially harm our business and financial performance.

WE MAY NEED  ADDITIONAL  FINANCING,  WHICH MAY BE  DIFFICULT  TO OBTAIN  AND MAY
RESTRICT OUR OPERATIONS AND DILUTE YOUR OWNERSHIP INTEREST

We may need to raise  additional  funds in the  future  to fund our  operations,
deliver our  products,  to expand or enhance  our  products  and  services or to
respond to competitive pressures or perceived opportunities.  We cannot make any
assurance that additional financing will be available on acceptable terms, or at
all. If adequate  funds are not available or not available on acceptable  terms,
our business and financial results may suffer.

The covenants in our outstanding 5% Senior  Convertible  Notes limit our ability
to raise  additional  debt.  If we raise  additional  funds  by  issuing  equity
securities,  further dilution to our then existing  stockholders will result and
the terms of the financing  may  adversely  affect the holdings or the rights of
such stockholders.  In addition,  the terms and conditions of debt financing may
result in  restrictions  on our  operations.  We could be required to seek funds
through  arrangements with collaborative  partners or others that may require us
to  relinquish  rights to certain of our  technologies,  product  candidates  or
products which we would otherwise pursue on our own.

                                       14
<PAGE>


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

Our quarterly  operating  results have  fluctuated in the past and may fluctuate
significantly  in the future.  Most of our expenses are fixed in the short-term,
and we may not be able to reduce  spending  quickly if our revenue is lower than
expected. In addition,  our ability to forecast revenue is limited. As a result,
our  operating  results are volatile and difficult to predict and you should not
rely on the  results of one  quarter  as an  indication  of future  performance.
Factors  that may cause our  operating  results to  fluctuate  include the risks
discussed in this section as well as:

     o    costs related to customization of our products and services;

     o    the  planned  expansion  of  our  operations,  including  opening  new
          offices,   hiring  new  personnel,   and  the  amount  and  timing  of
          expenditures related to this expansion;

     o    announcements  or  introductions  of new  products and services by our
          competitors;

     o    the failure of additional states to adopt legislation enabling the use
          of automated traffic safety enforcement systems;

     o    software defects and other product quality problems;

     o    the  discretionary  nature of our clients'  purchasing  and  budgetary
          cycles;

     o    the  varying  size,  timing  and  contractual  terms of orders for our
          products and services; and

     o    the mix of revenue from our products and services.

OUR  SALES  CYCLES  VARY  SIGNIFICANTLY  WHICH  MAKES IT  DIFFICULT  TO PLAN OUR
EXPENSES AND FORECAST OUR RESULTS

Our sales  cycles  typically  range from six to eighteen  months or more.  It is
therefore difficult to predict the quarter in which a particular sale will occur
and to plan our expenses  accordingly.  The period  between our initial  contact
with potential  clients and the  installation of our products and the use of our
services varies due to several factors, including:

     o    the complex nature of our products and services;

     o    the failure of the jurisdiction to adopt legislation  enabling the use
          of automated traffic safety enforcement  systems or political or legal
          challenges to existing legislation;

     o    the novelty of automated  enforcement in many jurisdictions and a lack
          of  familiarity  with  automated  enforcement  systems  on the part of
          legislative, executive and judicial bodies and the public;

     o    our clients' budget cycles;

     o    the selection,  award and contracting  processes at municipalities and
          other government  entities,  including  protests by other bidders with
          respect to competitive awards;

     o    our clients' internal evaluation, approval and order processes;

     o    the site evaluation and analysis process; and

     o    our clients'  delays in issuing  requests for proposals or in awarding
          contracts  because of  announcements  or planned  introductions of new
          products or services by our competitors.

                                       15
<PAGE>


Any delay or failure to complete sales in a particular  quarter could reduce our
revenue in that quarter,  as well as  subsequent  quarters over which revenue or
the  license  would  likely  be  recognized.  If our sales  cycles  unexpectedly
lengthen in general or for one or more large clients, it would delay our receipt
of the related  revenue.  If we were to  experience a delay of several  weeks or
longer on a large client,  it could harm our ability to meet our forecasts for a
given quarter.

IF WE LOSE OUR KEY  PERSONNEL  OR ARE  UNABLE TO ATTRACT  AND RETAIN  ADDITIONAL
PERSONNEL, OUR OPERATIONS WOULD BE DISRUPTED AND OUR BUSINESS WOULD BE HARMED

We believe that the hiring and retaining of qualified  individuals at all levels
in our  organization  will be  essential  to our  ability to sustain  and manage
growth  successfully.  Competition for highly qualified  technical  personnel is
intense and we may not be successful  in attracting  and retaining the necessary
personnel,  which  may  limit  the  rate at which we can  develop  products  and
generate sales.  We will be particularly  dependent on the efforts and abilities
of our  senior  management  personnel.  The  departure  of  any  of  our  senior
management members or other key personnel could harm our business.

OUR PRODUCTS MIGHT NOT ACHIEVE MARKET ACCEPTANCE

The market for our products is still emerging. The rate at which state and local
government bodies have adopted CrossingGuard has varied significantly by market,
and we  expect to  continue  to  experience  variations  in the  degree to which
CrossingGuard is accepted.  To date, no state or local government  bodies in our
market area have  adopted our speed  enforcement  products.  Our ability to grow
will depend on the extent to which our potential  customers accept our products.
This acceptance may be limited by:

     o    the failure of prospective customers to conclude that our products are
          valuable and should be acquired and used;

     o    the failure of additional states to adopt legislation enabling the use
          of automated traffic safety enforcement systems;

     o    the novelty of automated  enforcement in many jurisdictions and a lack
          of  familiarity  with  automated  enforcement  systems  on the part of
          legislative, executive and judicial bodies and the public;

     o    the reluctance of our prospective  customers to replace their existing
          solutions with our products;

     o    marketing efforts of our competitors; and

     o    the emergence of new technologies  that could cause our products to be
          less competitive or obsolete.

Because automated traffic  enforcement in the United States is still in an early
stage of  development,  we cannot  accurately  predict how large the market will
become,  and we have limited  insight into trends that may emerge and affect our
business.  For example,  without knowing how commonplace  automated  enforcement
will become, we may have difficulties in predicting the competitive  environment
that will develop.

OUR INTELLECTUAL PROPERTY MIGHT NOT BE PROTECTIBLE

We rely on a combination of copyright, trademark, patent, and trade-secret laws,
employee and third-party  nondisclosure  agreements,  and other  arrangements to
protect our proprietary  rights.  Despite these precautions,  it may be possible
for  unauthorized  third  parties  to  copy  our  products  or  obtain  and  use
information  that we  regard as  proprietary  to create  products  that  compete
against  ours.  In  addition,   some  license   provisions   protecting  against
unauthorized use, copying, transfer, and disclosure of our licensed programs may
be unenforceable under the laws of certain  jurisdictions and foreign countries.
In addition, the laws of some countries do not protect proprietary rights to the
same  extent  as  do  the  laws  of  the  United  States.  Were  we  to  conduct
international  activities,  our exposure to unauthorized  copying and use of our
products and proprietary  information would increase. The scope of United States
patent  protection in the software  industry is not well defined and will evolve


                                       16
<PAGE>


as the United  States Patent and Trademark  Office  grants  additional  patents.
Because some patent applications in the United States are not publicly disclosed
until the patent is issued or 18 months after the filing date,  applications may
exist that would relate to our  products  and that are not publicly  accessible.
Moreover,  a patent  search has not been  performed  in an  attempt to  identify
patents  applicable to our business  and, even if such a search were  conducted,
all patents applicable to the business might not be located.

IF WE FAIL TO PROTECT AND PRESERVE  OUR  INTELLECTUAL  PROPERTY,  WE MAY LOSE AN
IMPORTANT COMPETITIVE ADVANTAGE

On November 6, 2003,  we filed a complaint in the United States  District  Court
for Rhode Island against Redflex  Traffic Systems Inc.,  alleging that Redflex's
automated red light enforcement systems infringe our US Patent No. 6,188,329. On
November 25, 2003, we filed a complaint in the United States  District Court for
the District of Central  California  against  Transol USA,  Inc.,  alleging that
Transol's  automated red light enforcement systems infringe that patent. We were
denied a preliminary  injunction in the Transol litigation,  in part because the
court determined that we had not shown a likelihood of success on our claim that
Transol's product infringes our patent. We subsequently  filed additional claims
alleging  that  Transol  and  Redflex  have also  infringed  our US  Patent  No.
6,754,663,  but have withdrawn  that claim with respect to Redflex.  Transol has
filed a motion for summary judgment,  on which motion a hearing is scheduled for
April 11, 2005.

We cannot  give  assurance  that we will  succeed  in either  action.  If we are
unsuccessful in either action, it will be because either our one or both patents
are  invalidated  or because  our  competitors'  products  do not  infringe  our
patents.  Were one or more of our patents  invalidated,  our competitors will be
able to offer the technology  that those patents  describe and we would lose the
competitive  advantage  of being the  exclusive  source of  products  using that
technology. Were our competitors' products to be found to be non-infringing, our
competitors  would be able to  continue to market  products  that are similar to
ours and we would lose some of the  competitive  advantages  that we believe our
products enjoy.

WE ARE AT RISK OF CLAIMS THAT OUR PRODUCTS OR SERVICES  INFRINGE THE PROPRIETARY
RIGHTS OF OTHERS

Given our ongoing efforts to develop and market new  technologies  and products,
we may from time to time be served with claims from third parties asserting that
our products or technologies infringe their intellectual property rights. If, as
a  result  of  any  claims,  we  were  precluded  from  using   technologies  or
intellectual property rights, licenses to the disputed third-party technology or
intellectual  property  rights might not be available on  reasonable  commercial
terms, or at all. We may initiate claims or litigation against third parties for
infringement  of our  proprietary  rights or to  establish  the  validity of our
proprietary rights.  Litigation,  either as plaintiff or defendant, could result
in  significant  expense and divert the efforts of our technical and  management
personnel from  productive  tasks,  whether or not litigation is resolved in our
favor.  An adverse ruling in any litigation  might require us to pay substantial
damages,  to discontinue  our use and sale of infringing  products and to expend
significant  resources in order to develop  non-infringing  technology or obtain
licenses  for our  infringing  technology.  A court  might also  invalidate  our
patents,  trademarks or other proprietary rights. A successful claim against us,
coupled  with our failure to develop or license a substitute  technology,  could
cause  our  business,  financial  condition  and  results  of  operations  to be
materially  adversely affected.  As the number of software products increase and
the functionality of these products further  overlaps,  we believe that our risk
of infringement claims will increase.

IF WE ARE UNABLE TO SAFEGUARD THE INTEGRITY, SECURITY AND PRIVACY OF OUR DATA OR
OUR CLIENTS' DATA, OUR REVENUE MAY DECLINE,  OUR BUSINESS COULD BE DISRUPTED AND
WE MAY BE SUED

We need to preserve  and protect our data and our clients'  data  against  loss,
corruption  and  misappropriation  caused by system  failures  and  unauthorized
access.  We could be  subject  to  liability  claims by  individuals  whose data
resides  in  our  databases  for  misuse  of  personal  information,   including
unauthorized marketing purposes. These claims could result in costly litigation.
Periodically,  we have  experienced  minor  systems  errors  and  interruptions,
including Internet  disruptions,  which we believe may occur periodically in the
future.  A  party  who  is  able  to  circumvent  our  security  measures  could
misappropriate or destroy proprietary  information or cause interruptions in our
operations.  We may be  required  to make  significant  expenditures  to protect
against systems failures or security breaches or to alleviate problems caused by
any failures or breaches.  Any failure that causes the loss or corruption of, or


                                       17
<PAGE>


unauthorized access to, this data could reduce client satisfaction, expose us to
liability and, if significant, could cause our revenue to decline.

WE MAY MAKE  ACQUISITIONS,  WHICH COULD  DIVERT  MANAGEMENT'S  ATTENTION,  CAUSE
OWNERSHIP DILUTION TO OUR STOCKHOLDERS AND BE DIFFICULT TO INTEGRATE

We have expanded and may seek to continue to expand our  operations  through the
acquisition of additional  businesses  that  complement our core skills and have
the potential to increase our overall  value.  Our future growth may depend,  in
part, upon the continued success of our acquisitions.  Acquisitions involve many
risks,  which could have a material  adverse  effect on our business,  financial
condition and results of operations, including:

     o    acquired businesses may not achieve anticipated revenues,  earnings or
          cash flow;

     o    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;

     o    potential  dilutive effect on our stockholders from continued issuance
          of common stock as consideration for acquisitions;

     o    adverse effect on net income of impairment charges related to goodwill
          and other  intangible  assets and other  acquisition-related  charges,
          costs and expenses on net income;

     o    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; and

     o    disruption of our existing  business,  distraction  of management  and
          other  resources and  difficulty in maintaining  our current  business
          standards, controls and procedures.

THE FAILURE OF OUR SUPPLIERS TO DELIVER  COMPONENTS,  EQUIPMENT AND MATERIALS IN
SUFFICIENT QUANTITIES AND IN A TIMELY MANNER COULD ADVERSELY AFFECT OUR BUSINESS

Our business employs a wide variety of components,  equipment and materials from
a limited  number of  suppliers.  To date,  we have found  that the  components,
equipment and materials necessary for the development,  testing,  production and
delivery of our products and services have  sometimes not been  available in the
quantities or at the times we have required.  Our failure to procure components,
equipment  and materials in  particular  quantities or at a particular  time may
result in delays in meeting our  customer's  needs,  which could have a negative
effect on customer satisfaction and on our revenues and results of operations.

WE ARE SUBJECT TO POTENTIAL PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN COSTLY
AND TIME-CONSUMING LITIGATION

Although our license agreements  typically contain provisions  designed to limit
our exposure to product liability claims, existing or future laws or unfavorable
judicial  decisions could negate these limitation of liability  provisions.  Any
product  liability claim brought against us, even if unsuccessful,  would likely
be  time-consuming  and  costly,  and  potential  liabilities  could  exceed our
available insurance coverage.

                                       18
<PAGE>


RISKS RELATED TO OUR COMMON STOCK

OUR COMMON STOCK PRICE IS VOLATILE AND MAY DECLINE IN THE FUTURE

The market price of our common  stock has  fluctuated  significantly  and may be
affected  by our  operating  results,  changes in our  business,  changes in the
industries  in which we  conduct  business,  and  general  market  and  economic
conditions  which are beyond our  control.  In  addition,  the stock  markets in
general have recently experienced extreme price and volume  fluctuations.  These
fluctuations  have affected  stock prices of many  companies  without  regard to
their specific  operating  performance.  These market  fluctuations  may make it
difficult for stockholders to sell their shares at a price equal to or above the
price at which the  shares  were  purchased.  In  addition,  if our  results  of
operations are below the  expectations  of market  analysts and  investors,  the
market price of our common stock could be adversely affected.

OUR BOARD OF DIRECTORS CAN, WITHOUT STOCKHOLDER APPROVAL,  CAUSE PREFERRED STOCK
TO BE ISSUED ON TERMS THAT ADVERSELY AFFECT COMMON STOCKHOLDERS

Under our certificate of incorporation,  our board of directors is authorized to
issue up to 10,000,000  shares of preferred  stock,  of which 180,000 shares are
issued  and  outstanding,  and to  determine  the  price,  rights,  preferences,
privileges and  restrictions,  including voting rights,  of those shares without
any  further  vote or  action  by our  stockholders.  If the  board  causes  any
additional preferred stock to be issued, the rights of the holders of our common
stock would be adversely affected. The board's ability to determine the terms of
preferred stock and to cause its issuance, while providing desirable flexibility
in connection with possible  acquisitions  and other corporate  purposes,  could
have the  effect of  making it more  difficult  for a third  party to  acquire a
majority of our  outstanding  voting  stock.  We have no current  plans to issue
additional shares of preferred stock.

OUR DIRECTORS,  OFFICERS AND PRINCIPAL STOCKHOLDERS EXERCISE SIGNIFICANT CONTROL
OVER OUR  BUSINESS  AND  AFFAIRS,  INCLUDING  THE  APPROVAL OF CHANGE IN CONTROL
TRANSACTIONS

Our directors,  officers, and principal stockholders who own more than 5% of the
outstanding  common stock, and entities  affiliated with them,  beneficially own
approximately 52% of our common stock. These stockholders, acting together, will
be able to exert substantial  influence over all matters  requiring  approval by
our  stockholders.  These matters  include the election and removal of directors
and any merger, consolidation or sale of all or substantially all of our assets.
This  concentration  of ownership may have the effect of delaying,  deferring or
preventing a change in control, or impeding a merger, consolidation, takeover or
business  combination  even  if  the  transaction  might  be  beneficial  to our
stockholders.

In  addition,  Section 203 of the Delaware  General  Corporation  Law  restricts
business  combinations  with any  "interested  stockholder"  as  defined  by the
statute. The statute may have the effect of delaying,  deferring or preventing a
change in control of our company.

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 not paid any cash dividends since inception. We do not anticipate paying
any cash dividends in the foreseeable  future.  As a result,  our investors will
not be able to benefit  from owning our common  stock unless the market price of
our common stock  becomes  greater than the basis that these  investors  have in
their shares.

THE PRICE OF OUR COMMON STOCK MAY DECLINE  BECAUSE A  SUBSTANTIAL  AMOUNT OF OUR
COMMON STOCK IS AVAILABLE FOR TRADING IN THE PUBLIC

Availability of shares of our common stock could depress the price of our common
stock.  A  substantial  amount of common stock is  available  for trading in the
public  market.  The stock in the market may cause the price of our common stock


                                       19
<PAGE>


to decline.  In addition,  if our stockholders sell substantial numbers of stock
of our common stock in the public markets,  the market price of our common stock
could fall.  These sales might also make it more difficult for us to sell equity
or equity related securities at a time and price that we would deem appropriate.
We also have issued options,  warrants and convertible  securities  which can be
exercised  for, or converted to, shares of common stock,  many of which would be
freely  tradable  without   restrictions  or  further   registration  under  the
Securities Act of 1933.

There were approximately 18,777,790 shares of our common stock outstanding as of
March 17, 2005, of which 9,016,924 were freely tradable without  restrictions or
further registration under the Securities Act of 1933.

As of March 17,  2005,  we have issued and  outstanding  warrants and options to
purchase up to 2,951,066 shares of our common stock, preferred stock convertible
into 18,000 shares of our common stock and debt  convertible into 927,836 shares
of our common stock. The exercise of such warrants and options and conversion of
convertible  securities may dilute the interests of all  stockholders.  Possible
future resale of such  warrants and options or  conversion  of such  convertible
securities  could  adversely  affect the  prevailing  market price of our common
stock.

OUR  COMMON  STOCK  TRADES ON THE OTC  BULLETIN  BOARD AND MAY BE SUBJECT TO THE
SEC'S "PENNY STOCK" RULES

Our  stockholders  may  find  it  difficult  to buy,  sell  and  obtain  pricing
information  about,  as well as news coverage of, our common stock because it is
traded on the OTC Bulletin Board. Being traded on the OTC Bulletin Board, rather
than on a national  securities  exchange,  may lessen investors' interest in our
securities  generally and  materially  adversely  affect the trading  market and
prices for those securities and our ability to issue additional securities or to
secure  additional  financing.  The price of our common stock could make it more
difficult  for  stockholders  to sell their  shares.  Our  common  stock will be
subject to the penny stock rules under the  Securities  Exchange  Act of 1934 if
its price is less than $5.00 per share.  The last  reported  sale price on March
17, 2005 was $6.03 but our common stock traded below $5.00 per share  throughout
2002, 2003 and until mid-October 2004.

The  penny  stock  rules  impose  additional  sales  practice   requirements  on
broker-dealers who sell penny stock securities to people who are not established
customers or accredited  investors.  For example, the broker must make a special
suitability  determination  for the buyer and the  buyer  must be given  written
consent before the sale. The rules also require that the broker-dealer:

     o    send buyers an SEC-prepared  disclosure schedule before completing the
          sale, disclose the broker's commissions and current quotations for the
          security;

     o    disclose  whether the  broker-dealer  is the sole market maker for the
          penny stock and, if so, the broker's control over the market; and

     o    send monthly  statements  disclosing  recent price information held in
          the customer's  account and information on the limited market in penny
          stocks.

These   additional   burdens  may  discourage   broker-dealers   from  effecting
transactions in our common stock.  Thus, if our common stock were to fall within
the definition of a penny stock, our liquidity could be reduced, and there could
be an adverse effect on the trading market in its common stock.



                                       20
<PAGE>


ITEM 2. Properties.
        ----------

In 2000, we entered into a five-year  office lease  providing 9,600 square feet,
currently  at  $10,800  per  month,   located  at  400  Massasoit  Avenue,  East
Providence,  Rhode  Island.  In 2004,  we entered into a three year lease for an
additional 4,800 feet at the same location for  approximately  $5,400 per month,
subject to periodic adjustments.  We also maintain a local field office at 10225
Barnes Canyon Road,  San Diego,  California on a two-year lease dated July 2004,
and pay approximately  $2,600 per month. In addition,  we maintain a local field
office at 330 East  Orangethorpe  Ave. in  Placentia,  California  on a two-year
lease dated February 2004, and pay  approximately  $1,400 per month.  We believe
that these  facilities  are adequate to meet our current  needs but will require
additional  space as new  installations  increase  processing and support hiring
needs.

ITEM 3. Legal Proceedings.
        -----------------

On November 6, 2003,  we filed a complaint in the United States  District  Court
for Rhode Island against Redflex  Traffic Systems Inc.,  alleging that Redflex's
automated  red  light  enforcement  systems  infringe  on our  U.S.  Patent  No.
6,188,329  describing a system using  digitized  video and  integrating  traffic
light  violation   related  vehicle   information  with  court  date  scheduling
information.  Court-ordered  mediation  in that lawsuit took place on October 1,
2004, but no agreement was reached through that mediation.  Redflex has asserted
as a defense that our patent is invalid.

On November 25, 2003, we filed a complaint in the United States  District  Court
for the District of Central California against Transol USA, Inc.,  alleging that
Transol's  automated red light enforcement systems infringe on that same patent.
We were  denied a  preliminary  injunction  in the Transol  litigation,  in part
because we had not shown a  likelihood  of  success on our claim that  Transol's
products infringe on our patent.  Transol has filed a counterclaim asserting the
invalidity of that patent.

On June 22, 2004,  the United States  Patent and Trademark  Office issued Patent
Number 6,754,663 to us, describing a system using multiple cameras, including at
least one video camera,  to capture multiple images of a traffic light violation
and a user interface that simultaneously displays those multiple images.

On July 13, 2004, we filed an additional lawsuit for patent infringement against
Redflex  Traffic  Systems,  Inc.,  alleging that  Redflex's  automated red light
enforcement systems infringe our U.S. Patent Number 6,754,663, but we have since
withdrawn that additional lawsuit.

We have amended our lawsuit  against  Transol to include  claims  alleging  that
Transol's  automated  red light  enforcement  systems  infringe our U.S.  Patent
Number 6,754,663.  Transol has filed a counterclaim  asserting the invalidity of
that patent as well.

Transol  has moved  for  summary  judgment  against  us on all of our  claims of
infringement against Transol. A hearing on Transol's motion for summary judgment
is scheduled for April 11, 2005.

ITEM 4.    Submission   of   Matters   to   a   Vote   of   Security    Holders.
           --------------------------------------------------------------------

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of the year ended December 31, 2004.



                                       21
<PAGE>



                                                                         PART II

ITEM 5. Market for Registrant's Common Stock and Related Stockholder Matters.
        --------------------------------------------------------------------
The Company's common stock was first offered to the public in December 1983 and
is traded on the Nasdaq OTC Bulletin Board under the symbol "NESO." The prices
below have been adjusted to reflect the 1 for 10 reverse stock split during the
second quarter of 2003.
Before the stock split, the Company's common stock traded under the symbol
"NEST."
                                          Low            High
Year Ended December 31, 2004              ---            ----
         1st Quarter                    $ 2.85          $ 4.00
         2nd Quarter                    $ 3.16          $ 4.10
         3rd Quarter                    $ 4.05          $ 5.00
         4th Quarter                    $ 4.75          $ 7.85

Year Ended December 31, 2003
         1st Quarter                    $  .30          $ 1.90
         2nd Quarter                    $  .80          $ 2.60
         3rd Quarter                    $ 1.30          $ 2.05
         4th Quarter                    $ 1.60          $ 4.90

HOLDERS OF COMMON STOCK
At March 5, 2005, the number of holders of record of the issued and  outstanding
common stock of the Company was 458, which includes  brokers who hold shares for
approximately 1,994 beneficial holders.

DIVIDEND POLICY
The Company has not paid any cash  dividends  with  respect to its common  stock
since  formation  and does not expect to pay cash  dividends in the  foreseeable
future.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
Incorporated  by reference  from the Company's  definitive  proxy or information
statement to be filed with the Securities and Exchange Commission not later than
120 days following the end of the Company's fiscal year.


ITEM 6. Selected Financial Data.
        -----------------------
The  following  data  includes  the  accounts  of Nestor,  Inc.  for all periods
presented and NTS for the period  September  13, 2001 through  December 31, 2001
and the years 2004, 2003 and 2002. The Company's  investment in NTS was recorded
on the equity method through September 12, 2001.
<TABLE>
<CAPTION>

                                                                 Years Ended December 31,
                                    ----------------------------------------------------------------------------------
                                          2004            2003           2002             2001             2000
                                          ----            ----           ----             ----             ----

<S>                                 <C>             <C>              <C>             <C>              <C>
Revenue                             $  6,034,942    $  2,705,534     $  2,121,574    $  3,520,924     $  3,652,422
Operating loss                      $ (4,646,604)   $ (4,261,045)    $(15,127,235)   $ (1,297,145)    $ (1,548,777)
Gain on debt extinguishment, net    $    508,124    $        ---     $        ---    $        ---     $        ---
Contract termination reserve        $        ---    $   (125,000)    $        ---    $        ---     $        ---
Gain on royalty assignment          $        ---    $        ---     $  2,811,590    $        ---     $        ---
Other expense                       $   (334,116)   $   (504,413)    $   (318,618)   $   (186,809)    $   (106,675)
Net loss                            $ (4,472,596)   $ (4,890,458)    $(12,634,263)   $ (1,565,054)    $ (2,994,574)
Earnings per share
   Weighted number of outstanding
   shares - basic and diluted         18,223,609      12,964,498        5,047,611       2,881,877        1,790,160

   Loss per share                   $     (0.25)    $      (0.38)    $      (2.50)   $      (0.54)    $      (1.67)
SELECTED BALANCE SHEET DATA:
Total assets                        $ 18,847,164    $ 16,299,434     $  9,200,964    $ 22,035,420     $  4,922,703
Working capital (deficit)           $  6,785,719    $  3,294,231     $ (1,572,209)   $  1,775,401     $   (199,775)
Long-term
   Note and lease obligations       $  6,017,263    $  3,322,384     $  2,849,126    $  2,409,202     $        ---
   Deferred income                  $     53,472    $        ---     $        ---    $     421,399    $  2,036,896

(Note: Earnings per share information as previously reported at December 31, 2002 has been adjusted to a post-reverse split basis.)
</TABLE>



                                       22
<PAGE>



ITEM 7. Management's Discussion and Analysis
        ------------------------------------
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

The  following  discussion  includes  "forward-looking  statements"  within  the
meaning  of Section  21E of the  Securities  and  Exchange  Act of 1934,  and is
subject to the safe harbor created by that section.  Forward-looking  statements
give our current  expectations  or forecasts of future events.  All  statements,
other than  statements of historical  facts,  included or  incorporated  in this
report regarding our strategy,  future operations,  financial  position,  future
revenues,  projected  costs,  prospects,  plans and objectives of management are
forward-looking  statements.  The words "anticipates,"  "believes," "estimates,"
"expects,"  "intends," "may," "plans,"  "projects,"  "will," "would" and similar
expressions are intended to identify  forward-looking  statements,  although not
all  forward-looking  statements contain these identifying  words.  Factors that
could  cause  results  to  differ   materially   from  those  projected  in  the
forward-looking  statements  are set forth in this section and in the section of
this annual  report  captioned  "Risk  Factors That May Affect Our Results." The
following  discussion  should also be read in conjunction  with the Consolidated
Financial Statements and accompanying Notes thereto.

Readers  are  cautioned  not  to  place  undue  reliance  on  these  prospective
statements,  which  speak  only  as of the  date  of this  report.  The  Company
undertakes no obligation  to revise any  forward-looking  statements in order to
reflect events or circumstances that may subsequently  arise.  Readers are urged
to carefully review and consider the various  disclosures made by the Company in
this report and in the Company's  other reports  filed with the  Securities  and
Exchange Commission.

EXECUTIVE SUMMARY

The Company  primarily  operates through Nestor Traffic  Systems,  Inc. (NTS), a
wholly  owned   subsidiary.   NTS's  principal   product  is  its  CrossingGuard
video-based  red  light  enforcement  system  and  services.   CrossingGuard  is
marketed,  maintained,  and  distributed  through  direct  sales to  states  and
municipalities  in the  United  States.  In  August  2004,  NTS  entered  into a
distributorship agreement with Vitronic Machine Vision Ltd. for exclusive rights
to market and sell PoliScan,  a speed enforcement system,  throughout the United
States, Canada and Mexico, subject to minimum sales goals.

The  following  is a  summary  of  key  performance  measurements  monitored  by
management:
<TABLE>
<CAPTION>

                                               Quarter Ended December 31,             Year Ended December 31,
                                           ---------------------------------      ---------------------------------
                                                2004                 2003              2004                 2003
                                                ----                 ----              ----                 ----
Financial:
<S>                                       <C>                 <C>                 <C>                <C>
    Revenue                               $   1,551,000       $   1,122,000       $   6,035,000      $    2,706,000
    Loss from operations                      1,820,000           1,230,000           4,647,000           4,261,000
    Net loss                                  1,959,000           1,592,000           4,473,000           4,890,000
    Additional investment in
       capitalized systems                      310,000             822,000           1,829,000           2,341,000
    Cash and marketable equity securities                                             6,422,000           5,410,000
    Working capital                                                                   6,786,000           3,294,000


Number of CrossingGuard Approaches*:                                                        111                  88
     Installed and operational
     Authorized under existing contracts                                                    128                  47
                                                                                  -------------      --------------
     Total installed and planned                                                            239                 135


* At end of period. There can be no assurance that all approaches authorized under existing contracts will ultimately be installed.
</TABLE>

                                       23
<PAGE>


The  management  team  focus is to  expand  the  Company's  market  share in the
emerging  traffic safety  market.  The Company plans to expand that market share
by:

     o    Continuing to aggressively market CrossingGuard  video-based red light
          enforcement  systems and services to states and municipalities for red
          light enforcement and safety

     o    Implementing  a marketing  program for speed  enforcement  systems and
          services to states and municipalities for speed enforcement and safety

     o    Participating  in efforts to increase the public's  acceptance of, and
          state's authorization of, automated traffic safety systems

     o    Participating in industry standards setting bodies

     o    Enhancing  and seeking  patents for our traffic  safety  technology to
          maintain or improve our position  and  competitive  advantages  in the
          industry

     o    Vigorously   defending  our  patented   technology  from  competitors'
          infringement

LIQUIDITY AND CAPITAL RESOURCES

CASH POSITION AND WORKING CAPITAL

The Company had cash and short-term  investments of approximately  $5,850,000 at
December  31, 2004 as compared  with  approximately  $5,410,000  at December 31,
2003.  At December 31, 2004,  the Company had working  capital of  $6,786,000 as
compared  with  $3,294,000  at December 31,  2003.  The increase in cash in 2004
primarily  resulted  from  the  sale of  $6,000,000  of  convertible  notes  and
$3,440,000 of common stock in a private placement, offset by $2,179,000 of lease
financing repayments,  $2,061,000 invested in capitalized systems,  property and
equipment and cash used by operations.

Working capital was favorably impacted by the net effect of these factors as the
current portion of the Laurus Note ($885,000) and lease  ($639,000)  payables at
December 31, 2003 were eliminated.  Marketable equity securities of $572,000 and
a $590,000  increase in  inventory  at December  31,  2004 also  contributed  to
increased working capital at that date.

In  November  2004,  the  Company  completed  the sale of $6  million  aggregate
principal amount of its 5% Senior Convertible Notes to accredited investors in a
private placement, resulting in net proceeds to the Company of $5,555,000.

In January 2004,  the Company  received  $3,440,000 in proceeds from the private
placement of common stock,  $2,179,000 of which was used to settle the remaining
lease  obligation  to  Electronic  Data  Systems   Corporation  (EDS).  The  EDS
settlement  resulted in a gain on early  extinguishment  of debt of $681,000 and
eliminated the 12% interest obligation.

Also in January  2004,  the Company  satisfied its  obligations  on a $2 million
convertible  note  issued to Laurus  Master  Fund,  Ltd. in July 2003 by issuing
492,904  shares of Nestor  common stock and repaying the note  balance,  accrued
interest and prepayment penalty. On the same date, the Company issued a new $1.5
million  convertible  note to Laurus.  Although Nestor received $98,000 as a net
result of these  transactions,  the more  beneficial  change was  increasing the
fixed  conversion  price,  as defined in the notes,  from $1.55 per share in the
first note to $3.50 in the second note. During 2004, the Company repaid $195,000
of principal in cash and the balance of the note was converted into common stock
by November 2004.

                                       24
<PAGE>


The Company had a net worth of  $10,779,000  at December 31,  2004,  as compared
with a net worth of $9,662,000  at December 31, 2003.  The increase in net worth
is further detailed on the Consolidated Statements of Stockholders' Equity.

FUTURE COMMITMENTS

During 2004,  the Company  acquired  additional  property  and leased  equipment
(primarily  computers and related  equipment) at a cost of $232,000 and invested
$1,829,000 in capitalized  systems.  At December 31, 2004,  Nestor  recorded its
investments in computers and related equipment (net of depreciation) at $357,000
and in capitalized  systems (net of depreciation to an estimated residual value)
at $3,749,000.  Management expects that NTS will make future commitments for the
purchase of additional computers and related computing equipment,  for furniture
and fixtures, for leasehold  improvements,  for delivery of capitalized systems,
for consulting and for promotional and marketing expenses.

The Company does not generally  grant payment terms to customers in excess of 90
days.

The  Company's  future  contractual  obligations  and other  commitments  are as
follows:

Contractual Obligations and Commercial Commitments:

                                                 Payment Due Date
                     ----------------------------------------------------------
                       Total     < 1 Year     1-3 Years   3-5 Years  Thereafter
                       -----      --------    ---------   ---------  ----------

Senior Convertible
  Note              $6,000,000   $    ---    $6,000,000    $   ---    $    ---

Operating leases    $  314,000   $198,000    $  116,000    $   ---    $    ---

Inflation

Management  believes  that the rate of  inflation  in recent years has not had a
material effect on the Company's operations.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Nestor's  consolidated  financial  statements  are prepared in  accordance  with
accounting principles generally accepted in the United States, which require the
Company  to make  estimates  and  assumptions  (see  Note 2 to the  Consolidated
Financial  Statements).  The Company believes that of its significant accounting
policies (see Note 2 to the Consolidated  Financial  Statements),  the following
may involve a higher degree of judgment and complexity.

Unbilled Contract Revenue

Unbilled contract revenue represents revenue earned by the Company in advance of
being billable under customer  contract  terms.  Under the terms of some current
contracts,  the  Company  cannot  bill the  municipality  until  the  court  has
collected the citation fine.  Management  records  unbilled  contract revenue in
these situations at a net amount, based upon a historical pattern of collections
by the courts  for the  municipalities.  The  pattern  of  collections  on these
citations is continually reviewed and updated by management.

Revenue Recognition

Revenue is derived  mainly from the lease of products  which  incorporate  NTS's
software and the delivery of services based upon such products.  Product license
and service fees include software  licenses and processing  service fees tied to
citations issued to red-light  violators.  NTS provides  equipment (either under
direct sales or lease agreements),  postcontract customer processing and support
services,  and  engineering  services.  In  arrangements  that include  multiple

                                       25
<PAGE>


elements, some of which include software, the total arrangement fee is allocated
among  each  deliverable  based  on the  relative  fair  value  of  each  of the
deliverables determined based on vendor-specific objective evidence.  Management
estimates the percentage of citations  that are expected to be  collectible  and
recognizes revenue accordingly.  To the extent these estimates are not accurate,
the Company's operating results may be significantly and negatively affected.

Long Term Asset Impairment

In assessing the  recoverability  of the Company's long term assets,  management
must make assumptions  regarding  estimated future cash flows,  contract renewal
options and other factors to determine the fair value. If these estimates change
in the future,  the Company may be required to record  impairment  charges  that
were not previously recorded.

RESULTS OF OPERATIONS

In 2004,  the Company  focused on marketing and selling the Company's  principal
product,   CrossingGuard,  a  video-based  red  light  enforcement  system  with
ancillary  support  services.  During 2003, the Company completed the transition
from several lines of business,  including  financial  services/PRISM,  Rail and
TrafficVision,  which had  previously  generated  the  majority of  revenue,  to
red-light  enforcement  services and products as the ongoing  operating focus of
the  Company.  Future  growth  will  depend  on an  increase  in the  number  of
CrossingGuard  approaches  installed and operational  and successful  efforts to
develop and penetrate the automated speed enforcement market.

ANALYSIS OF THE THREE-MONTH PERIODS ENDED DECEMBER 31, 2004 AND 2003

In the quarter ended  December 31, 2004,  the Company  realized a $428,000 (38%)
increase in revenues  and a  $1,018,000  (43%)  increase in  operating  expenses
compared  to last year's  fourth  quarter.  The  Company  reported a net loss of
$1,959,000  compared to $1,592,000 in last year's fourth quarter.  The increased
revenue relates primarily to $400,000 of revenue recorded under sales-type lease
accounting for Delaware  approaches  installed  during the current year quarter.
Operating  expense includes a corresponding  $214,000 Delaware cost of sales, an
increase  of  $290,000  in  amortization  on  capitalized   systems,  and  costs
associated  with the  development of a larger sales force  ($116,000  additional
internal sales expense,  and $125,000  additional  consultant  expenses).  Other
expenses--net  in the  fourth  quarter  of 2003  included  the  write off of the
unamortized discount on the first Laurus note and EDS interest expense.


Revenues
--------

The Company's revenues arose from  CrossingGuard  lease and service fees. During
the quarter ended December 31, 2004,  revenues  increased $426,000 to $1,548,000
from $1,122,000 in last year's fourth quarter. This increase is due primarily to
additional revenue from Delaware installations along with increased revenue from
a larger installation base.

Operating Expenses
------------------

Total  operating  expenses  amounted to $3,371,000 in the quarter ended December
31, 2004,  an increase of  $1,018,000  as compared to total  operating  costs of
$2,353,000 in last year's fourth quarter.

Cost of Goods Sold

Cost of goods sold (CGS)  totaled  $1,307,000  in the fourth  quarter of 2004 as
compared to $614,000 in last year's fourth  quarter.  This year's fourth quarter
included $214,000 of costs associated with the Delaware installations,  $184,000
of  accelerated  amortization  on certain  installed  approaches  which were not
renewed and a $106,000 overall increase in systems  amortization due to a larger
installed  base.  Last  year's  fourth  quarter  also  includes a  $417,000  net
reclassification  of all 2003 citation  processing  costs from  engineering  and
operations, as previously presented, to CGS.

                                       26
<PAGE>


Engineering and Operations

Costs  related to  engineering  and  operations  totaled  $999,000 in the fourth
quarter of 2004,  as compared  with  $745,000 in 2003.  These costs  include the
salaries of field and office personnel as well as operating  expenses related to
product design, delivery,  configuration,  maintenance and service. This expense
increased in 2004 as there were more  customers  and  installations  to support.
Increases in headcount and travel generated  $149,000 of additional costs in the
2004 quarter and the inventory  reserve,  established  in 2004,  rose by $43,000
during the current year quarter.  The 2003 comparable period includes a $417,000
net reclassification of all 2003 citation processing costs to CGS.

Research and Development

Research and development  expenses totaled $32,000 in the quarter ended December
31, 2004 as compared with $29,000 in the previous  year's  quarter.  The Company
continues its R&D activities, as deemed necessary.

Selling and Marketing

Selling and  marketing  costs were  $377,000 in the quarter  ended  December 31,
2004, and $87,000 in the previous year's quarter.  The increase  reflects a more
aggressive  marketing  effort,  including the cost  associated with a nationwide
sales force. Outside consultants are also being used to cover strategic markets.
Attendance at trade shows escalated, as did the purchase of collateral material.

General and Administrative

General and  administrative  expenses  totaled $654,000 in the fourth quarter of
2004, as compared with $876,000 in the previous year's quarter.  The decrease is
primarily due to a $140,000  reduction in financing fees and a $62,000 reduction
in bad debt  expense,  offset by a $39,000  increase in patent  lawsuit  defense
expenses.

Other Expense

For this year's fourth quarter,  net other expense was $139,000 as compared with
$362,000  in  the  quarter-earlier  period.  The  decrease  of  $223,000  is due
primarily to the  non-reoccurrence  of a $169,000  write off of the  unamortized
discount  on the first  Laurus note in 2003 and a $27,000  reduction  in warrant
amortization as warrants were fully amortized in July 2004.

Net Loss
--------

During the fourth quarter 2004, the Company experienced a loss of $1,959,000, as
compared  with a loss of  $1,592,000  in the previous  year's  quarter.  For the
quarter ended December 31, 2004,  loss per share  available for common stock was
$0.11 per share, consistent with the corresponding period of the prior year. The
weighted  average  shares  outstanding  were  18,619,771  for the quarter  ended
December 31, 2004 and 13,987,905 for the quarter ended December 31, 2003.


ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2004 AND 2003

For  the  year  ended  December  31,  2004,  the  Company   experienced  a  123%
($3,329,000) increase in revenues compared to the prior calendar year. Operating
expenses  increased 53% ($3,715,000) in 2004. The Company reported a net loss of
$4,473,000  in 2004  compared to a loss of  $4,890,000  in the prior year.  Many
significant  changes  occurred  during  these two years as more fully  described
below.

                                       27
<PAGE>


Revenues
--------

The Company's revenues arose from royalties and product sales, lease and service
fees, as discussed  separately  below.  During the year ended December 31, 2004,
revenues  increased  $3,329,000  to  $6,035,000  from  $2,706,000  in the  prior
calendar year.

Product Royalties

Product  royalties  totaled  $37,000 in 2004,  as compared with $29,000 in 2003.
Residual royalty streams from two customers account for all royalty revenues.

Product Sales, Lease and Service Fees

Product  sales,  lease and service fee revenues  totaled  $5,998,000 in 2004, as
compared with  $2,677,000 in 2003.  This increase is largely  attributable  to a
full year of revenues in 2004 on 44  approaches  installed  on various  dates in
2003,  proceeds  received  under the Master  Lease  Agreement  with the State of
Delaware and revenues  recognized in  connection  with our ACS agreement for the
city of Baltimore.  The Company continues to retrofit some operating  approaches
to improve  performance and is working with its customers to complete build outs
of remaining approaches committed under existing contracts.

Operating Expenses
------------------

Total operating  expenses amounted to $10,682,000 in the year ended December 31,
2004, an increase of $3,715,000  over total operating costs of $6,967,000 in the
prior year. The primary changes in 2004 include  increased  amortization on live
approaches,  an increase in CGS as a result of the  Delaware  installations  and
Baltimore  revenue,  a significant  increase in sales consulting  expenses,  and
$381,000 of  additional of lawsuit  defense  expenses.  Additionally,  headcount
increased  33% in 2004 over 2003,  which  caused an  increase  in  salaries  and
fringes, and related travel expenses.

Costs of Goods Sold

Cost of goods sold totaled  $3,932,000  in 2004 as compared to $1,791,000 in the
prior year. CGS includes amortization,  maintenance and processing costs related
to revenues  recorded in the  respective  periods.  The current year increase is
primarily  due to an  increase  of  $990,000  of  amortization  (more  installed
approaches), including $184,000 of accelerated amortization on certain installed
approaches which were not renewed,  $558,000 of Delaware systems installed under
sales-type  lease  accounting  and $232,000 of costs  associated  with Baltimore
revenue.

Engineering and Operations

Costs  related to  engineering  and  operations  totaled  $3,464,000 in 2004, as
compared with $2,578,000 in 2003.  These costs include the salaries of field and
office  personnel  as well as  operating  expenses  related to  product  design,
delivery,  configuration,  maintenance and service.  The increase in these costs
reflects the additional expenses both internally and field-based, to support the
growing installed customer base. Engineering and operations staff growth in 2004
includes redeployment of five people from other departments to field support, in
addition to six new employees hired. Expenses such as travel, tools and supplies
increased, as well.

Research and Development

Research and development  expenses  totaled  $157,000 in the year ended December
31, 2004 as compared  with  $121,000 in the prior year.  The increase in 2004 is
directly  attributable  to materials  purchased in support of on-going  research
activities.

                                       28
<PAGE>


Selling and Marketing

Selling and  marketing  costs  increased  $519,000 to $874,000 in the year ended
December 31, 2004,  from $355,000 in the prior year.  The increase in 2004 costs
reflects the hiring of a  nationwide  sales force with  outside  consultants  to
support sales activity in strategic markets.

General and Administrative

General and administrative expenses totaled $2,254,000 in 2004, as compared with
$2,121,000 in the previous year. The $133,000 increase is largely the net result
of $381,000  increased 2004 patent lawsuit  defense costs,  offset by a $124,000
reduction  in 2004  financing  fees  and last  year's  $180,000  expense  for an
employee settlement agreement.

Gain on Debt Extinguishment
---------------------------

Obligations to EDS and Laurus (under the July 2003 note) were fully satisfied in
January  2004,  resulting  in a net gain of $508,000.  The early  payment to EDS
resulted in a gain of $681,000, which was offset in part by a prepayment penalty
of $173,000 incurred in the Laurus settlement.

Contract Termination Reserve
----------------------------

A significant  customer  contract in the Rail line of business was terminated by
mutual  agreement prior to its completion as a result of the Company's  decision
to focus its  resources  on  CrossingGuard  systems  and  services.  The Company
accrued $125,000 of estimated  contract  termination fees in June 2003.  Payment
was satisfied in December 2004.

Other Expense
-------------

For 2004, net other expense was $334,000;  as compared with net other expense of
$504,000 in the year-earlier  period. In 2004, other expense included $80,000 of
interest  expense  accrued  as a result  of a 2004  sales and use tax  audit,  a
decrease of  $144,000 in interest  expenses  associated  with notes  payable,  a
realized loss on  marketable  equity  securities  of $96,000,  and a decrease of
$44,000 in warrant  amortization  as warrants were fully amortized in July 2004.
Non-recurring 2003 items include $164,000 of interest expense paid to EDS offset
by a $64,000 favorable vendor settlement.

Net Loss
--------

During 2004, the Company recorded a loss of $4,473,000,  as compared with a loss
of $4,890,000 in the prior year. For the year ended December 31, 2004,  loss per
share  was  $0.25  per  share,  as  compared  with a loss per  share of $0.38 in
corresponding  period of the prior fiscal year.  For the year ended December 31,
2004, there was outstanding a weighted average of 18,223,609 shares, as compared
to 12,964,498 shares in the year-earlier period.

ANALYSIS OF THE YEARS ENDED DECEMBER 31, 2003 AND 2002

For the year ended December 31, 2003,  the Company  experienced a 28% ($584,000)
increase in revenues  compared to the prior  calendar year.  Operating  expenses
decreased 60% ($10,282,000) in 2003. After  consideration of the $2,812,000 gain
on royalty  assignment in 2002 and $311,000 of increased other expenses in 2003,
the  Company  reported a net loss of  $4,890,000  in 2003  compared to a loss of
$12,634,000 in the prior year. Many  significant  changes  occurred during these
two years as more fully described below.

Revenues
--------

The Company's revenues arose from royalties and product sales, lease and service
fees as discussed  separately  below.  During the year ended  December 31, 2003,
revenues  increased $584,000 to $2,706,000 from $2,122,000 in the prior calendar
year.  CrossingGuard  accounted for 40% of 2002 revenues and  substantially  all
2003 revenues.

                                       29
<PAGE>


Ongoing  revenues from the risk management  product line continued under the ACI
distributor agreement until July 2002 when it was assigned to CLA.

Product Royalties

Product  royalties  totaled  $29,000 in 2003, as compared with $664,000 in 2002.
The  Company  continued  to receive  royalties  from ACI until July 1, 2002 when
these royalty rights were assigned to Churchill Lane Associates,  LLC.  Residual
royalty streams from two customers account for 2003 royalty revenues.

Product Sales, Lease and Service Fees

Product sales,  lease and service fee revenues from the traffic business totaled
$2,677,000 in 2003, as compared  with  $1,457,000 in 2002,  due primarily to the
installed  base of  approaches  more than  doubling  from  December  31, 2002 to
December 31, 2003.  Revenue in 2002 was  comprised of $844,000 in  CrossingGuard
video-based  traffic  enforcement,  $387,000 in Rail  business  and  $187,000 in
TrafficVision   business,   whereas   2003   revenue   was   substantially   all
CrossingGuard.

CrossingGuard  construction started slowly in Q1 '03 but by the end of Q2, there
were 20 additional  approaches  installed,  followed by 12 and 16 more in Q3 and
Q4,  respectively,  to total 88 live approaches by the end of 2003. During March
2004, the Company  installed  three new  approaches  under its contract with the
Delaware  Department of  Transportation.  The Company is currently  retrofitting
some  operating  approaches  to  improve  performance  and is  working  with its
customers  to  complete  build  outs of  remaining  approaches  committed  under
existing contracts.

Operating Expenses
------------------

Total operating  expenses  amounted to $6,967,000 in the year ended December 31,
2003, a decrease of $10,282,000 over total operating costs of $17,249,000 in the
prior  year.  The 2002  expenses  include  $743,000 in  restructuring  costs and
$9,294,000  of  impairment  charges.   Excluding  restructuring  and  impairment
charges,  operating  expenses  in 2002  were  $7,212,000.  The most  significant
changes in 2003 were  $414,000 of  increased  amortization  on live  approaches,
$240,000 of  increased  financing  fees and $130,000 of patent  lawsuit  defense
expenses;  offset by $538,000 of CGS expense pertaining to discontinued  product
lines (Rail, TrafficVision) and pilot programs.

Costs of Goods Sold

Cost of goods sold totaled  $1,791,000  in 2003 as compared to $1,476,000 in the
prior year. CGS includes amortization,  maintenance and processing costs related
to  revenues  recorded in the  respective  periods.  Fiscal  year 2002  includes
$289,000 (Rail), $138,000 (TrafficVision) and $111,000 (pilot program) CGS which
did not recur in 2003 but were  offset by a $414,000  current  year  increase in
system  amortization due to the increased  number of installed  approaches and a
$417,000 net reclassification of 2003 citation processing costs from engineering
and  operations as previously  presented to CGS.  Additionally,  2002 included a
$102,000 reversal of EDS processing costs which were not repeated in 2003.

Engineering and Operations

Costs  related to  engineering  and  operations  totaled  $2,578,000 in 2003, as
compared with $2,070,000 in 2002.  These costs include the salaries of field and
office  personnel  as well as  operating  expenses  related to  product  design,
delivery,  configuration,  maintenance and service.  The increase in these costs
reflects  the addition of NTS  expenses  both  internally  and  field-based,  to
support the growing installed  customer base. Staff realignments from R & D were
necessary  to assist in  engineering  efforts.  Also,  $417,000 of net  citation
processing  costs was  reclassified  to CGS in  fourth  quarter  2003.  Citation
processing  costs were not material to 2002  engineering and operations and were
not reclassified to conform to the 2003 presentation.

                                       30
<PAGE>


Research and Development

Research and development  expenses  totaled  $121,000 in the year ended December
31, 2003 as compared  with  $1,604,000 in the prior year. R & D efforts had been
significant to roll out the Rail and CrossingGuard  products,  which occurred in
2002.  In March  2002,  management  took  steps to reduce the heavy use of third
party contractors to support development projects (consulting costs decreased by
$183,000 in 2003) and also made staff  realignments to assist  engineering  with
the  increased  customer  base.  Although  the June 2002  restructuring  further
contributed to a $361,000 reduction in salaries,  talent and capacity remain for
research and development, as management deems appropriate.

Selling and Marketing

Selling and  marketing  costs  decreased  $253,000 to $355,000 in the year ended
December  31,  2003,  from  $608,000 in the prior year.  The decrease in selling
costs in the year reflects,  primarily,  the re-focus of strategy to one product
line, which lowered salaries and collateral  costs.  Sales and marketing efforts
had been limited  recently due to cash  constraints but are expected to increase
in 2004.

General and Administrative

General and administrative expenses totaled $2,121,000 in 2003, as compared with
$1,453,000 in the previous  year. The increase is the net result of (i) $240,000
of financing fees in conjunction  with the July 2003 Laurus and the October 2003
Silver Star notes,  (ii) $130,000 of legal expenses on patent  lawsuit  defense,
(iii) $102,000 in general legal  expenses,  (iv) $84,000 of bad debt expense and
(v) the 2002 reversal of $113,000 of Wand  Partners,  Inc.  fees in  conjunction
with a Termination and Release Agreement.

Restructuring Costs

In June 2002,  the  Company  underwent  a  significant  restructuring  involving
management  changes and cost control to lower personnel and facilities  expenses
as the Company  refocused its efforts solely on its red-light video  enforcement
contracts for CrossingGuard  installations.  The Company terminated 19 full-time
employees, affecting all departments, and offices were consolidated into smaller
facilities.  During  the  quarter  ended June 30,  2002,  the  Company  recorded
restructuring  costs of  $743,000  primarily  comprised  of $332,000 in employee
severance agreements and estimated lease obligations associated with closing its
Providence,  RI and San Diego,  CA offices.  A settlement was reached in 2002 in
connection  with the Providence  office lease and in 2003 in connection with the
San Diego office lease.

Capitalized Systems Costs Impairment

During the quarter ended June 30, 2002,  the Company  determined  that potential
citation revenues from certain  CrossingGuard  installations in two cities would
not exceed the cost of the underlying carrying value of the capitalized systems.
These contracts were signed in the early stages of CrossingGuard development and
the site selection  procedures  and contract terms have since been improved.  In
accordance  with SFAS No. 144,  "Accounting  for the  Impairment  or Disposal of
Long-Lived Assets",  the Company wrote off capitalized systems costs of $794,000
and recorded a corresponding  impairment charge in operating  expenses.  Ongoing
revenues from these  installations are expected to offset future costs of system
operations.

Goodwill Impairment Loss

On January 1, 2002,  the  Company  adopted  SFAS No.  142,  "Goodwill  and Other
Intangible  Assets."  Under SFAS No. 142,  the Company  will test  goodwill  for
impairment  on an  annual  basis,  or  whenever  indicators  of  impairment  are
identified.  The Company completed the transitional  impairment test of goodwill
during the quarter ended June 30, 2002 and concluded that no impairment  existed
on January 1, 2002,  when the  standard was adopted.  Management  considers  the
Company's quoted stock price to be the best indicator of fair value for purposes
of performing these analyses.

                                       31
<PAGE>

Based on the decline of the Company's stock price during the second and third
quarters of 2002, however, the fair value was recomputed using the quoted
quarter-end stock prices. Such computations resulted in goodwill impairment
charges of $3,000,000 and $5,500,000 recorded as operating expenses during the
respective 2002 quarters. The Company continues to monitor goodwill for
potential impairment.

Gain on Royalty Assignment

On July 15, 2002, the Company entered into a Memorandum of Understanding ("MOU")
with  Churchill  Lane  Associates,  LLC  ("CLA"),  assigning  CLA certain of the
Company's  rights to royalty  income  under the  license  agreement  between the
Company and ACI ("ACI License").  CLA is owned and controlled by Alan M. Wiener,
Alvin J. Siteman and Robert M. Carroll, former directors and shareholders of the
Company. The MOU also provided a schedule for advances by CLA to provide interim
financing to the Company during the period prior to the closing. Upon closing on
September  30, 2002,  CLA paid the Company $3.1 million in cash (less  advances)
for the irrevocable  assignment of its royalty rights under the ACI License from
July 1, 2002 and in  perpetuity.  No  obligations or other rights of the Company
were transferred or assigned to CLA.

After  offsetting  $860,000 of ACI unbilled  contract  revenue,  $632,000 of ACI
deferred income and $60,000 in related professional fees, the Company recorded a
$2,812,000  gain  on  this  royalty   assignment  on  September  30,  2002.  The
elimination of ACI unbilled  contract  revenue and deferred income were recorded
as non-cash reductions.

Contract Termination Reserve

A significant  customer  contract in the Rail line of business may be terminated
by  mutual  agreement  prior  to its  completion  as a result  of the  Company's
decision to focus its  resources  on  CrossingGuard  systems and  services.  The
Company accrued $125,000 of estimated contract termination fees in June 2003.

Other Expense
-------------

For 2003, net other expense was $504,000;  as compared with net other expense of
$319,000 in the year-earlier  period.  In 2003, other expense included  interest
expense of  $470,000 as  compared  to  $217,000  in 2002,  2003 also  included a
$64,000  favorable  settlement with a vendor and both years included $106,000 of
amortization  expense related to the assigned value of warrants  outstanding and
being amortized over their remaining life. Interest expense was high in 2003 due
to the $169,000 write off of the  unamortized  discount on the first Laurus note
and $59,000 of other Laurus interest.

Net Loss
--------

During 2003, the Company  experienced a loss of  $4,890,000,  as compared with a
loss of  $12,634,000  in the prior year.  For the year ended  December 31, 2003,
loss per share was $0.38 per share,  as compared  with a loss per share of $2.50
in the  corresponding  period  of the  prior  fiscal  year.  For the year  ended
December  31,  2003,  there was  outstanding  a weighted  average of  12,964,498
shares, as compared to 5,047,611 shares in the year-earlier period.

ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk.
         ----------------------------------------------------------

The  Company's  marketable  equity  securities  (primarily  cash reserves and an
insured  municipal  bond fund),  valued at $572,000 at December  31,  2004,  are
exposed to market risk due to changes in U.S. interest rates and fluctuations in
foreign  currency  exchange  rates.  The  primary  objective  of  the  Company's
investment   activities  is  the  preservation  of  principal  while  maximizing
investment income. The Company's exposure to this risk is moderately high in the
short-term.  During  2004,  the  Company  realized  a net  loss  of  $96,000  on
securities  sold and has an  unrealized  loss of $10,000 on  securities  held at
December 31, 2004. The securities  are  classified as "trading  securities"  and
accordingly are reported at fair value with unrealized gains and losses included
in other income (expense).

The Company has a senior  convertible  note  payable with  interest  fixed at 5%
through its October 2007 maturity. Management assesses the exposure to this risk
as immaterial.

                                       32
<PAGE>


ITEM 8.   Financial Statements and Supplementary Data
          -------------------------------------------

See annexed financial statements.


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

None.


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

An evaluation was performed under the supervision and with the  participation of
our  management,  including  the Chief  Executive  Officer  and Chief  Financial
Officer,  of the  effectiveness  of the design and  operation  of the  Company's
disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) and
15d-15(e) as of December 31, 2004. Based on that evaluation, the Chief Executive
Officer and Chief  Financial  Officer  concluded  that the Company's  disclosure
controls  and  procedures  were  effective  as of such date in that they provide
reasonable  assurance  that  information  required to be  disclosed by us in the
reports  we file or  submit  under  the  Exchange  Act is  recorded,  processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. No change in the Company's internal control over financial  reporting (as
defined in Rules 13a -15(f) and 15d - 15(f)  under the  Exchange  Act)  occurred
during the fiscal quarter ended December 31, 2004 that has materially  affected,
or is reasonably  likely to materially  affect,  the Company's  internal control
over financial reporting.


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

On March 25, 2005,  Nigel P. Hebborn was appointed  Executive  Vice President of
Nestor, Inc. Mr. Hebborn previously served as Chief Operating Officer of Nestor,
Inc. He will continue to serve as President and Chief  Executive  Officer of the
Company's wholly owned subsidiary, Nestor Traffic Systems, Inc. His compensation
will remain unchanged from that previously reported.

Also on March 25, 2005,  Tadas A. Eikinas was appointed Chief Operating  Officer
of Nestor,  Inc. Mr. Eikinas had been leading the Company's  efforts to develop,
market  and  implement  speed  products.  Prior to joining  Nestor in 2004,  Mr.
Eikinas was Director of Peek Traffic's red light and speed enforcement  products
division.  In connection with his appointment as Chief  Operating  Officer,  the
Company entered into an employment agreement with Mr. Eikinas on March 29, 2005.
Mr. Eikinas's  employment  agreement  provides for a base salary of $175,000 per
year, an option grant and bonuses based on reaching project objectives. The term
of the  agreement is from its date until  December 31, 2008 and by its own terms
renews for one year unless the Company elects not to renew by October 31, 2008.

The employment agreement provides that in the event of Mr. Eikinas's termination
without cause or resignation for good reason,  each as defined in the agreement,
Mr.  Eikinas  will  receive one year's  base salary and one year of  accelerated
vesting with  respect to his option.  The option  granted is to purchase  30,000
shares of Nestor's  common  stock at $5.95 per share,  of which 10,000 vest upon
grant, 10,000 vest on March 29, 2006 and 10,000 vest on March 29, 2007.

Mr.  Eikinas  will  receive a bonus of $12,500  and an  immediately  exercisable
option to  purchase  25,000  shares of the  Company's  common  stock at the then
current  fair  market  value if, on or before  October  31,  2005,  the  Company
satisfactorily  delivers, as reasonably determined by the Compensation Committee
of the Board, a "speed on green" product other than to defined test markets.  In
addition,  he will  receive a bonus of $12,500  and an  immediately  exercisable
option to  purchase  25,000  shares of the  Company's  common  stock at the then
current  fair  market  value if, on or before  October  31,  2005,  the  Company
satisfactorily  delivers, as reasonably determined by the Compensation Committee
of the Board, a mobile speed product other than to defined test markets. He will
also receive an immediately  exercisable option to purchase 25,000 shares of the
Company's  common  stock at the then  current fair market value if, on or before
December 31, 2005, the Company  successfully  develops and tests,  as reasonably
determined by the  Compensation  Committee of the Board, a CrossingGuard  system
using all digital  imaging.  The  Compensation  Committee may grant Mr.  Eikinas
additional bonuses in its sole discretion.

                                       33
<PAGE>


Also on March 25, 2005 Benjamin M.  Alexander was appointed  Vice  President and
General Counsel of Nestor,  Inc. Mr.  Alexander had been of counsel to Partridge
Snow & Hahn LLP and served as the  Company's  outside  counsel  since  2003.  In
connection  with his  appointment  as Vice  President and General  Counsel,  the
Company  entered into an employment  agreement  with Mr.  Alexander on March 29,
2005.  Mr.  Alexander's  employment  agreement  provides  for a base  salary  of
$165,000 per year, an option grant and bonuses in the  Compensation  Committee's
sole  discretion.  The term of the agreement is from its date until December 31,
2008 and by its own terms  renews for one year unless the Company  elects not to
renew by October 31, 2008.

The  employment  agreement  provides  that  in  the  event  of  Mr.  Alexander's
termination without cause or resignation for good reason, each as defined in the
agreement,  Mr. Alexander will receive one year's base salary and three years of
accelerated vesting with respect to his option The option granted is to purchase
135,000 shares of Nestor's common stock at $5.95 per share, of which 10,000 vest
upon grant,  15,000 vest on March 1, 2006, 20,000 vest on March 29, 2007, 25,000
vest on March 29,  2008,  30,000 vest on March 29, 2009 and 35,000 vest on March
29, 2010.

Each of the  options  granted to Messrs.  Eikinas  and  Alexander  provide  that
following  a change in control  of the  Company,  in the event of a  termination
without  cause or a  resignation  for good  reason by either  will result in the
immediate vesting of that officer's option in its entirety.

Also on March 25, Harold A. Joannidi was appointed  Chief  Financial  Officer of
Nestor, Inc., effective as of April 4, 2005. Claire M. Iacobucci,  the Company's
Chief Financial  Officer since April 2004 and employee since 1997, had requested
that the  Company  appoint a new Chief  Financial  Officer so as to allow her to
return to a  part-time  work  schedule.  Mr.  Joannidi's  annual  salary will be
$125,000.  Upon the  commencement of his  employment,  Mr. Joannidi will receive
options to purchase  100,000 shares of Nestor's common stock at the then current
market price.  Twenty thousand of those options will be immediately  exercisable
and an additional  20,000 will vest on each of the first four  anniversaries  of
his employment by the Company.

Subsequent  to Mr.  Joannidi's  appointment  as  Chief  Financial  Officer,  Ms.
Iacobucci tendered her resignation, effective as of April 15, 2005.




                                       34
<PAGE>





                                                                         PART II


ITEM 8.





                        CONSOLIDATED FINANCIAL STATEMENTS




                                    FORM 10-K




                                December 31, 2004



                                       35
<PAGE>






                                  NESTOR, INC.
                                  ------------

                                    CONTENTS
                                    --------







                                                                  Page No.
                                                                  --------

Report of Independent Registered Public Accounting Firm              37

Consolidated Balance Sheets -
 December 31, 2004 and 2003                                          38

Consolidated Statements of Operations -
 For the Years Ended December 31, 2004, 2003 and 2002                39

Consolidated Statements of Stockholders' Equity -
 For the Years Ended December 31, 2004, 2003 and 2002                40

Consolidated Statements of Cash Flows -
 For the Years Ended December 31, 2004, 2003 and 2002                41

Notes to Consolidated Financial Statements                           42



                                       36
<PAGE>












             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders
Nestor, Inc.
East Providence, Rhode Island



We have audited the accompanying  consolidated balance sheets of Nestor, Inc. as
of  December  31,  2004 and 2003,  and the related  consolidated  statements  of
operations,  stockholders'  equity and cash flows for each of the three years in
the  period  ended  December  31,  2004.  These  financial  statements  are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the consolidated  financial position of Nestor,  Inc. at
December 31, 2004 and 2003, and the  consolidated  results of its operations and
its cash flows for each of the three  years in the  period  ended  December  31,
2004, in conformity with accounting  principles generally accepted in the United
States of America.

                                                /s/ Carlin, Charron & Rosen, LLP

Providence, Rhode Island
March 18, 2005


                                       37
<PAGE>


<TABLE>
<CAPTION>

                                                       NESTOR, INC.
                                                Consolidated Balance Sheets
                                                ---------------------------
                                                                                           DECEMBER 31,
                      ASSETS                                                         2004                2003
                                                                                     ----                ----

<S>                                                                             <C>                <C>
CURRENT ASSETS:
    Cash and cash equivalents                                                   $   5,849,992      $   5,410,123
    Marketable equity securities                                                      571,860                ---
    Accounts receivable, net of allowance for doubtful accounts                       763,573            521,872
    Unbilled contract revenue                                                         111,117            158,952
    Inventory, net                                                                  1,031,891            442,298
    Other current assets                                                              307,938             75,791
                                                                                -------------      -------------
      Total current assets                                                          8,636,371          6,609,036

NONCURRENT ASSETS:
    Capitalized system costs, net of accumulated depreciation                       3,749,293          3,514,908
    Property and equipment, net of accumulated depreciation                           357,052            385,165
    Goodwill                                                                        5,580,684          5,580,684
    Patent development costs, net of accumulated amortization                         161,740            175,216
    Other long term assets                                                            362,024             34,425
                                                                                -------------      -------------

TOTAL ASSETS                                                                    $  18,847,164      $  16,299,434
                                                                                =============      =============


       LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Note payable                                                                $         ---      $     884,750
    Accounts payable                                                                  620,013            468,289
    Accrued employee compensation                                                     460,556            386,652
    Accrued liabilities                                                               655,406            745,676
    Deferred revenue                                                                   91,667             20,000
    Leases payable                                                                     23,010            662,541
    Restructuring reserve                                                                 ---            146,897
                                                                                -------------      -------------
      Total current liabilities                                                     1,850,652          3,314,805

NONCURRENT LIABILITIES:
    Long term note payable                                                          6,000,000          1,030,000
    Asset retirement obligation                                                       146,577                ---
    Long term deferred revenue                                                         53,472                ---
    Long term leases payable                                                           17,263          2,292,384
                                                                                -------------      -------------
      Total liabilities                                                             8,067,964          6,637,189
                                                                                -------------      -------------

    Commitments and contingencies                                                         ---                ---

STOCKHOLDERS' EQUITY:
    Preferred stock, $1.00 par value, authorized 10,000,000 shares;
      issued and outstanding:  Series B - 180,000 shares at
      December 31, 2004 and 190,000 shares at December 31, 2003                       180,000            190,000
    Common stock, $.01 par value, authorized 30,000,000 shares;
      issued and outstanding:   18,673,498 shares at December 31, 2004
      and 13,997,238 shares at December 31, 2003                                      186,735            139,972
    Warrants                                                                           66,358          1,377,251
    Additional paid-in capital                                                     62,430,361         49,230,803
    Stock pending issuance                                                                ---          6,335,877
    Accumulated deficit                                                           (52,084,254)       (47,611,658)
                                                                                -------------      -------------
      Total stockholders' equity                                                   10,779,200          9,662,245
                                                                                -------------      -------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                      $  18,847,164      $  16,299,434
                                                                                =============      =============


See Notes to the Financial Statements.
</TABLE>


                                                              38
<PAGE>

<TABLE>
<CAPTION>


                                                            NESTOR, INC.
                                              Consolidated Statements of Operations
                                              -------------------------------------

                                                                          YEARS ENDED DECEMBER 31,
                                                                 2004                2003               2002
                                                            ----------------------------------------------------

<S>                                                         <C>                 <C>                <C>
Revenue:
     Product royalties                                      $      36,691       $      28,555      $     664,401
     Product sales, lease and service fees                      5,998,251           2,676,979          1,457,173
                                                            -------------       -------------      -------------

         Total revenue                                          6,034,942           2,705,534          2,121,574
                                                            -------------       -------------      -------------

Operating expenses:
     Cost of goods sold                                         3,931,962           1,791,203          1,475,945
     Engineering and operations                                 3,463,754           2,578,056          2,070,476
     Research and development                                     157,396             121,350          1,604,159
     Selling and marketing                                        873,946             354,847            607,901
     General and administrative                                 2,254,488           2,121,123          1,453,342
     Restructuring costs                                              ---                 ---            742,705
     Capitalized system costs impairment                              ---                 ---            794,281
     Goodwill impairment loss                                         ---                 ---          8,500,000
                                                            -------------       -------------      -------------
         Total operating expenses                              10,681,546           6,966,579         17,248,809
                                                            -------------       -------------      -------------


Loss from operations                                           (4,646,604)         (4,261,045)       (15,127,235)

Gain on debt extinguishment, net                                  508,124                 ---                ---
Contract termination reserve                                          ---            (125,000)               ---
Gain on royalty assignment                                            ---                 ---          2,811,590
Other expense - net                                              (334,116)           (504,413)          (318,618)
                                                            -------------       -------------      -------------

Net loss                                                    $  (4,472,596)      $  (4,890,458)     $ (12,634,263)
                                                            =============       =============      =============


Loss Per Share:

Loss per share, basic and diluted                           $        (.25)      $       (0.38)      $      (2.50)
                                                            =============       =============       ============

Shares used in computing loss per share:
     Basic and diluted                                         18,223,609          12,964,498          5,047,611
                                                            =============       =============      =============


See Notes to the Financial Statements.

</TABLE>




                                                              39
<PAGE>


<TABLE>
<CAPTION>

                                                                  Nestor, Inc.
                                                Consolidated Statements of Stockholders' Equity

                                              For the Years Ended December 31, 2004, 2003 and 2002
                                              ----------------------------------------------------



                     Preferred Stock        Common Stock                      Additional      Stock
                   -----------------    --------------------                    Paid-in     Pending      Accumulated
                   Shares     Amount     Shares      Amount      Warrants       Capital     Issuance      Deficit          Total
                   ------     ------     ------      ------      --------     ----------   ----------   ------------       -----
<S>                <C>      <C>         <C>        <C>        <C>            <C>           <C>          <C>            <C>
Balance at
 Dec. 31, 2001     235,000  $235,000    5,024,111  $ 50,241   $ 2,612,368    $43,581,825   $      ---   $(30,086,937)  $ 16,392,497
Accretion value
 of warrants           ---       ---          ---       ---       106,483            ---          ---            ---        106,483
Variable
 warrants              ---       ---          ---       ---    (1,646,026)     1,646,026          ---            ---            ---
Loss for the
 year ended
 Dec. 31, 2002         ---       ---          ---       ---           ---            ---          ---    (12,634,263)   (12,634,263)
                   -------  --------   ----------  --------   -----------    -----------   ----------    -----------   ------------
Balance at
Dec. 31, 2002      235,000  $235,000    5,024,111  $ 50,241   $ 1,072,825    $45,227,851   $      ---    (42,721,200)  $  3,864,717


Issuance of
 Common Stock          ---       ---    8,968,627    89,686           ---      3,997,561          ---            ---      4,087,247
Conversion
 of Preferred
 Stock to
 Common Stock      (45,000   (45,000)       4,500        45           ---         44,955          ---            ---            ---
Stock issuance
 outstanding           ---       ---          ---       ---           ---            ---    6,335,877            ---      6,335,877
Issuance of
 warrants              ---       ---          ---       ---           ---        158,378          ---            ---        158,378
Accretion value
 of warrants           ---       ---          ---       ---       106,484            ---          ---            ---        106,484
Variable
 warrants              ---       ---          ---       ---       197,942       (197,942)         ---            ---            ---
Loss for the
 year ended
 Dec. 31, 2003         ---       ---          ---       ---           ---            ---          ---     (4,890,458)    (4,890,458)
                  --------  --------   ----------  --------   -----------     ----------   ----------    -----------   ------------
Balance at
 Dec. 31, 2003     190,000  $190,000   13,997,238  $139,972   $ 1,377,251    $49,230,803   $6,335,877   $(47,611,658)  $  9,662,245


Issuance of
 Common Stock          ---       ---    3,519,384    35,194           ---      9,721,121   (6,335,877)           ---      3,420,438
Conversion of
 Laurus notes
 payable               ---       ---      865,761     8,658           ---      2,060,342          ---            ---      2,069,000
Exercise of
 cashless
 warrants              ---       ---      262,115     2,621           ---         (2,623)         ---            ---             (2)
Exercise of
 incentive
 stock
 options               ---       ---       28,000       280           ---         37,720          ---            ---         38,000
Conversion
 of Preferred
 Stock to
 Common Stock      (10,000   (10,000)       1,000        10           ---          9,990          ---            ---            ---
Accretion value
 of warrants           ---       ---          ---       ---        62,115            ---          ---            ---         62,115
Expired
 warrants              ---       ---          ---       ---    (1,225,000)     1,225,000          ---            ---            ---
Variable
 warrants              ---       ---          ---       ---      (148,008)       148,008          ---            ---            ---
Loss for the
 year ended
 Dec. 31, 2004         ---       ---          ---       ---           ---            ---          ---     (4,472,596)    (4,472,596)
                  --------  --------   ----------  --------   -----------    -----------   ----------    -----------   ------------
Balance at
Dec. 31, 2004      180,000  $180,000   18,673,498  $186,735   $    66,358    $62,430,361   $      ---   $(52,084,254)  $ 10,779,200
                   =======  ========   ==========  ========   ===========    ===========   ==========   ============  =============


      See Notes to the Financial Statements.

</TABLE>

                                                              40
<PAGE>


<TABLE>
<CAPTION>


                                                                  NESTOR, INC.
                                                      Consolidated Statements of Cash Flows
                                                      -------------------------------------

                                                                             YEARS ENDED DECEMBER 31,
                                                                    2004               2003                2002
                                                              -----------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                         <C>                 <C>                <C>
  Net loss                                                  $  (4,472,596)      $  (4,890,458)     $ (12,634,263)
    Adjustments to reconcile net loss
      to net cash used by operating activities:
      Depreciation and amortization                             2,037,217           1,012,123            601,938
      Loss on disposal of fixed assets                              5,378               5,291             17,402
      Gain on extinguishment of debt, net                        (508,124)                ---                ---
      Unrealized loss on marketable equity securities               9,912                 ---                ---
      Realized loss on marketable equity securities                96,367                 ---                ---
      Dividends reinvested                                        (34,898)                ---                ---
      Goodwill impairment loss                                        ---                 ---          8,500,000
      Capitalized system costs impairment                             ---                 ---            794,281
      Gain on royalty assignment                                      ---                 ---         (2,811,590)
      Expenses charged to operations relating to
       options, warrants and capital transactions                  62,115             264,862            106,483
      Increase (decrease) in cash arising from
       changes in assets and liabilities:
        Restricted cash                                               ---                 ---            943,926
        Accounts receivable, net                                 (241,701)           (380,609)            16,943
        Unbilled contract revenue                                  47,835             (36,268)            32,841
        Inventory, net                                           (599,634)           (178,210)            46,447
        Other assets                                             (498,746)             83,041            108,740
        Accounts payable and accrued expenses                     163,152            (137,129)          (257,207)
        Deferred income                                           125,139              20,000           (270,904)
        Restructuring reserve                                    (146,897)           (219,042)           365,939
                                                            -------------       -------------      -------------

        Net cash used by operating activities                  (3,955,481)         (4,456,399)        (4,439,024)
                                                            -------------       -------------      -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Investment in marketable equity securities                   (1,500,000)                ---                ---
  Liquidation of marketable equity securities                     856,759                 ---                ---
  Proceeds from royalty assignment, net                               ---                 ---          3,040,100
  Investment in capitalized systems                            (1,829,373)         (2,341,114)        (1,016,985)
  Purchase of property and equipment                             (232,267)            (86,145)           (47,849)
  Proceeds from sale of property and equipment                        ---                 ---             11,600
  Patent development costs                                         (5,633)            (31,196)           (21,818)
                                                            -------------       -------------      -------------

        Net cash provided (used) by investing activities       (2,710,514)         (2,458,455)         1,965,048
                                                            -------------       -------------      -------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Repayment of obligations under capital leases                (2,260,115)           (292,641)           (42,647)
  Proceeds from notes payable                                   6,098,028           4,000,000                ---
  Repayment of note payable                                      (195,000)                ---                ---
  Proceeds from leases payable                                        ---                 ---            530,530
  Proceeds from issuance of common stock,  net                  3,462,951           4,001,997                ---
  Proceeds from stock pending issuance                                ---           4,306,727                ---
                                                            -------------       -------------      -------------

        Net cash provided by financing activities               7,105,864          12,016,083            487,883
                                                            -------------       -------------      -------------

Net change in cash and cash equivalents                           439,869           5,101,229         (1,986,093)
Cash and cash equivalents - beginning of year                   5,410,123             308,894          2,294,987
                                                            -------------       -------------      -------------

Cash and cash equivalents - end of year                     $   5,849,992       $   5,410,123      $     308,894
                                                            =============       =============      =============

SUPPLEMENTAL CASH FLOWS INFORMATION:
  Interest paid                                             $      92,577       $     361,730      $      89,431
                                                            =============       =============      =============

  Income taxes paid                                         $         ---       $         ---      $         ---
                                                            =============       =============      =============


Significant non-cash transactions are described in Notes 4, 6, 7, 11 and 15.
See Notes to the Financial Statements.
</TABLE>

                                                              41
<PAGE>



                                  NESTOR, INC.
                        NOTES TO THE FINANCIAL STATEMENTS

NOTE 1 -  NATURE OF OPERATIONS
          A.   Organization
               Nestor,  Inc.  was  organized  on March 21,  1983 in  Delaware to
               develop and succeed to certain patent rights and know-how,  which
               was acquired from its predecessor,  Nestor Associates,  a limited
               partnership.   Two  wholly-owned  subsidiaries,   Nestor  Traffic
               Systems,    Inc.   ("NTS")   and   Nestor    Interactive,    Inc.
               ("Interactive"), were formed effective January 1, 1997. Effective
               November 7, 1998,  Nestor,  Inc. ceased further investment in the
               Interactive  subsidiary.  CrossingGuard,  Inc.,  a  wholly  owned
               subsidiary  of NTS, was formed July 18, 2003 in  connection  with
               the financing  discussed in Note 6. The  consolidated  financials
               statements   include  the  accounts  of  Nestor,   Inc.  and  its
               wholly-owned  subsidiaries   (collectively  referred  to  as  the
               "Company").  All intercompany transactions and balances have been
               eliminated.  The  Company's  principal  office is located in East
               Providence, RI.

               The Company's  current focus is to offer  customers  products and
               services  to  be  utilized  in  intelligent   traffic  management
               applications.   Its   leading   product   is  its   CrossingGuard
               video-based red light enforcement  system and services,  sold and
               distributed  exclusively  by NTS.  Effective  July 1,  2002,  the
               Company  assigned  its royalty  rights in the field of  financial
               services,   substantially  eliminating  ongoing  product  royalty
               revenue from prior non-traffic related lines of business.

          B.   Liquidity and management's plans
               The  Company  has  incurred  significant  losses  to date  and at
               December 31, 2004 has an accumulated deficit. Management believes
               that the significant financing obtained in 2004, strong liquidity
               at December 31, 2004 and current  contracts  with  municipalities
               will enable the Company to continue the development and upgrading
               of its products and sustain  operations  through the end of 2005.
               There can be no assurance, however, that the Company's operations
               will be sustained  or be  profitable  in the future,  or that the
               Company's  product  development  and  marketing  efforts  will be
               successful.


NOTE 2 -  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
          A.   Cash equivalents
               The  Company   considers  all  highly  liquid  debt   instruments
               purchased with an original maturity of 90 days or less to be cash
               equivalents.

          B.   Marketable equity securities
               The Company's marketable equity securities consist of investments
               in closed-end  insured  municipal bond funds.  The securities are
               classified as "trading  securities"  and accordingly are reported
               at fair value with unrealized  gains and losses included in other
               income (expense).

          C.   Accounts receivable
               Accounts receivable  represents balances due from customers,  net
               of an $84,213 reserve for doubtful  accounts at December 31, 2004
               and 2003. The reserve was established during 2003. In determining
               the  need  for an  allowance,  objective  evidence  that a single
               receivable is uncollectible  as well as an historical  pattern of
               collections of accounts  receivable that indicate that the entire
               face amount of a  portfolio  of  accounts  receivable  may not be
               collected is considered at each balance sheet date.

          D.   Unbilled contract revenue
               Unbilled  contract  revenue  represents  revenue  earned  by  the
               Company in  advance of being  billable  under  customer  contract
               terms.  Under the terms of some  current  contracts,  the Company
               cannot bill the  municipality  until the court has  collected the
               citation fine.  Management  records unbilled  contract revenue in

                                       42
<PAGE>


               these situations at a net amount, based upon a historical pattern
               of collections by the courts for the municipalities.  The pattern
               of  collections on these  citations is  continually  reviewed and
               updated by management.

          E.   Inventory
               Inventory  is valued at the  lower of cost or  market,  with cost
               determined by the first-in,  first-out  basis and consists mostly
               of equipment to be installed as  capitalized  system  costs.  The
               December 31, 2004 inventory balance is presented net of a $50,000
               inventory reserve which was established during the year.

          F.   Property and equipment & depreciation and amortization
               Property and  equipment  are recorded at cost.  Depreciation  and
               amortization  are calculated  using the  straight-line  method at
               rates  sufficient  to write off the cost of the assets over their
               estimated useful lives.

          G.   Goodwill
               Goodwill represents the excess of cost over the fair value of net
               assets  acquired.  Statement  of Financial  Accounting  Standards
               (SFAS) No. 142, "Goodwill and Other Intangible  Assets," requires
               that  goodwill be tested for  impairment  at least  annually  and
               whenever  events or changes in  circumstances  indicate  that the
               carrying amount of the asset may not be recoverable.  Goodwill is
               reviewed for impairment using the Company's quoted stock price as
               a measurement  of the Company's  fair value of assets,  including
               goodwill, and liabilities. Any resulting goodwill impairment will
               be charged to operations.

          H.   Product and patent development costs
               The  costs  of  development  of the  Company's  software  - which
               consist  primarily  of labor and  outside  consulting  and are an
               inherent cost of the  Company's  business - and costs of research
               and development are expensed until technological  feasibility has
               been  established  for  the  product.  Thereafter,  all  software
               production costs are capitalized and subsequently reported at the
               lower of unamortized  cost or net realizable  value.  Capitalized
               costs are amortized on a  straight-line  basis over the estimated
               economic life of the product.  The Company currently has no costs
               eligible  for  capitalization  under the  American  Institute  of
               Certified Public Accountants Statement of Position 98-1.

               Patent-development   costs  are  expensed  or   capitalized,   as
               appropriate.   Amortization   of   capitalized   costs  is  on  a
               straight-line  basis over the shorter of the  estimated  economic
               life, or statutory life, of the patent.

          I.   Revenue recognition
               Revenue  is  derived  mainly  from the lease of  products,  which
               incorporate  NTS's  software,  and the delivery of services based
               upon such  products.  Lease and  service  fees  include  software
               licenses and processing  service fees tied to citations issued to
               red-light  violators.  NTS provides equipment (either under sales
               or operating  lease  agreements)  and  engineering  services.  In
               arrangements  that  include  multiple  elements,  some  of  which
               include  software,  the total  arrangement fee is allocated among
               each deliverable  based on the relative fair value of each of the
               deliverables   determined  based  on  vendor-specific   objective
               evidence.

               Product Sales - The Company  recognizes the revenue  allocable to
               product sales upon delivery of the product.

               Lease and Service Fees - The Company recognizes lease and service
               fee revenue from operating lease arrangements with customers over
               the  terms  of  the  lease  agreements.  The  majority  of  NTS's
               CrossingGuard  revenues are  expected to be  generated  from fees
               received from red-light  violation citations issued by the system
               and  associated  services.   Revenues  are  recognized  upon  the

                                       43
<PAGE>

               issuance of the related  tickets.  To the extent that maintenance
               is provided, it is billed and recognized on a monthly basis.

               Deferred revenue - Certain  customer  contracts allow the Company
               to bill  and/or  collect  payment  prior  to the  performance  of
               services, resulting in deferred revenue.

               Contracts  may  include  penalty  provisions  relating  to timely
               performance and delivery.  Penalties are charged to operations as
               incurred.

          J.   Shipping and handling costs
               Shipping and handling  costs are  capitalized if part of a leased
               system or included in engineering services expense.

          K.   Research and development
               Research  and  development  costs  associated  with NTS  products
               consist  principally  of payroll  and related  costs,  facilities
               costs and the cost of prototype components.

          L.   Income taxes
               The Company accounts for income taxes using the liability method.
               Under  this  method,  deferred  tax assets  and  liabilities  are
               determined based on differences  between the financial  reporting
               and the tax bases of assets  and  liabilities,  and are  measured
               using  enacted tax rates and tax laws that will be in effect when
               the differences are expected to reverse. The primary component of
               the deferred tax asset, which is fully reserved, is net operating
               loss carry forwards.

               Although the Company  reports  consolidated  results and balances
               for financial reporting purposes,  the individual  companies file
               separate tax  returns.  Due to operating  losses  throughout  the
               reporting periods, no provision for income tax has been made.

          M.   Earnings (loss) per share and common stock
               The Company  reports  its  earnings  (loss) per share  ("EPS") in
               accordance   with  the   provisions  of  Statement  of  Financial
               Accounting  Standards  No. 128,  Earnings Per Share ("SFAS 128").
               Basic EPS is  calculated by dividing the net income (loss) by the
               weighted  average  number of common  shares  outstanding  for the
               period,  without  consideration  for  common  stock  equivalents.
               Diluted EPS is computed giving effect to common stock equivalents
               and other dilutive securities,  unless the computation results in
               anti-dilution.  Diluted per share  computations are not presented
               since the effect would be anti-dilutive.

               Common stock and loss per share as  previously  reported for 2002
               have been adjusted to a post-reverse  split basis effective April
               21, 2003.

          N.   Estimates
               The  preparation  of  financial  statements  in  conformity  with
               accounting  principles generally accepted in the United States of
               America  requires  management to make  estimates and  assumptions
               that affect the reported  amounts of assets and  liabilities  and
               disclosure of contingent  assets and  liabilities  at the date of
               the financial statements and the reported amounts of revenues and
               expenses during the reporting period. Actual results could differ
               from those estimates.

          O.   Concentrations of credit risk
               The  Company's   financial   instruments   that  are  exposed  to
               concentrations  of credit risk consist primarily of cash and cash
               equivalents,  marketable  equity  securities  and trade  accounts
               receivable.  The  Company  places  its  cash and  temporary  cash
               investments with high credit quality institutions.  At times such
               investments may be in excess of the FDIC limit.  However,  senior
               management  continually  reviews the financial stability of these
               financial   institutions.   The   Company's   marketable   equity
               securities (primarily cash reserves and an insured municipal bond
               fund) are exposed to market risk due to changes in U.S.  interest
               rates and  fluctuations in foreign  currency  exchange rates. The

                                       44
<PAGE>


               Company's  exposure  to  this  risk  is  moderately  high  in the
               short-term. The securities are classified as "trading securities"
               and accordingly are reported at fair value with unrealized  gains
               and  losses  included  in other  income  (expense).  The  Company
               routinely assesses the financial strength of its customers,  most
               of which are municipalities,  and, as a result, believes that its
               trade accounts  receivable  credit risk exposure is limited.  The
               Company does not require collateral from its customers.

          P.   Stock option plans
               The Company accounts for stock option awards granted to officers,
               directors  and  employees  (collectively  "employees")  under the
               recognition and measurement  principles of Accounting  Principles
               Board Opinion No. 25,  "Accounting for Stock Issued to Employees"
               ("APB 25").  Under APB 25, no stock-based  employee  compensation
               cost is  reflected  in net  income,  as all  options  granted  to
               employees  under  these  plans have been  granted at no less than
               fair market value on the date of grant.  The Company  applies the
               disclosure  only  provision of Statement of Financial  Accounting
               Standards   ("SFAS")  No.  123,   "Accounting   for   Stock-based
               Compensation"  ("SFAS  123") and SFAS No.  148,  "Accounting  for
               Stock-based  Compensation-Transition  and Disclosure ("SFAS 148")
               for such employee stock option awards.  The Company  accounts for
               stock option awards granted to  consultants  under the fair value
               recognition  provisions of SFAS 123.  Under this method,  options
               are valued using the Black-Scholes  option pricing model, and the
               calculated  option  value  is  recorded  as  an  expense  in  the
               financial statements.

               For  purposes of  providing  pro forma  disclosures  for employee
               grants,  the fair value for options was  estimated at the date of
               grant using the  Black-Scholes  pricing  model with the following
               weighted average assumptions:

<TABLE>
<CAPTION>

                                                         2004           2003          2002
                                                         ----           ----          ----
<S>                                                <C>            <C>             <C>
               Expected life (years)                        8              8               8
               Average risk-free
                interest rate                      1.6 to 6.8%    1.6 to 6.8%     2.6 to 6.8%
               Volatility                               113.2%         117.4%          109.8%
               Dividend yield                               0%             0%              0%
</TABLE>

               The  weighted-average  fair value of options granted during 2004,
               2003 and 2002 was  $4.17,  $2.55  and  $1.80,  respectively.  The
               Company recognizes forfeitures as they occur.

               Had the Company determined  compensation  expense for the Plan in
               accordance  with the fair value  methodology  prescribed  by SFAS
               123,  the  Company's  pro forma net loss and loss per share would
               have been:
<TABLE>
<CAPTION>

                                                             Years Ended December 31,
                                                  -------------------------------------------
                                                         2004           2003          2002
                                                         ----           ----          ----
<S>                                               <C>            <C>            <C>
               Net loss - reported                $(4,472,596)   $(4,890,458)   $(12,634,263)
               Add (Deduct):  total stock-based
                 compensation expense
                 determined under fair-value
                 based method for all awards,
                 net of related tax effects       $(4,912,682)   $   149,965    $    (22,464)
               Pro Forma - net loss               $(9,385,278)   $(4,740,493)   $(12,656,727)
               Pro forma net loss per share -
                 basic and diluted                $     (0.52)   $     (0.37)   $      (2.51)
</TABLE>

               For the purposes of this disclosure,  the estimated fair value of
               the options is amortized  to expense  over the  options'  vesting
               periods.  The effects on pro forma  disclosures  of applying SFAS
               123  may  not be  representative  of  the  effects  on pro  forma
               disclosures of future years.

                                       45
<PAGE>


          Q.   Asset retirement obligations
               Effective January 1, 2002, the Company  implemented SFAS No. 143,
               "Accounting for Asset  Retirement  Obligations,"  which addresses
               financial  accounting  and reporting for  obligations  associated
               with the retirement of tangible long-lived assets and the related
               asset  retirement  costs.  The  statement  requires that the fair
               value  of a  liability  for an  asset  retirement  obligation  be
               recognized in the period in which it is incurred and  capitalized
               as part of the carrying  amount of the long-lived  asset.  When a
               liability is initially recorded,  the entity capitalizes the cost
               by increasing the carrying value of the related long-lived asset.
               Over time,  the  liability is accreted to its present  value each
               period,  and the capitalized  cost is depreciated over the useful
               life of the related asset.  Upon  settlement of the liability,  a
               gain or loss is  recorded.  As  required  by SFAS  No.  143,  the
               Company  records an obligation for the cost to remove its systems
               and remediate the site, if contractually required.

          R.   Reclassification
               Certain prior year balances have been  reclassified to conform to
               the current year  presentation.  These  reclassifications  had no
               effect on the 2003 net loss as previously reported.


NOTE 3 -  CAPITALIZED SYSTEM COSTS:
          Equipment,  installation,  and in some cases interest costs related to
          operating lease contracts are capitalized and, after acceptance by the
          municipality  (customer),   are  depreciated  over  the  term  of  the
          contract,  generally  either three or five years,  less an  applicable
          residual value. Revenues realized from these agreements,  generally in
          the form of  per-citation or monthly fees, are expected to be adequate
          to cover the capitalized and future costs related to these agreements.
          Most leases contain  minimum  payment  requirements,  which  currently
          aggregate to  $2,842,362 in 2005,  $2,239,977  in 2006,  $1,543,443 in
          2007,  $902,917 in 2008 and $0 in 2009,  but  management  expects that
          these  annual  amounts  could  increase  and extend to future years as
          additional intersections are installed.


                                                           December 31,
                                                     2004               2003
                                                     ----               ----
          Equipment under operating leases:
                Work-in-process                  $    43,021        $   248,693
                Installed and accepted             6,551,184          4,358,062
                                                 -----------        -----------
                                                   6,594,205          4,606,755

          Less: Accumulated depreciation          (2,844,912)        (1,091,847)
                                                 ------------       -----------

          Net investment in leased equipment     $ 3,749,293        $ 3,514,908
                                                 ===========        ===========


NOTE 4 -  PROPERTY AND EQUIPMENT - NET:
                                                           December 31,
                                                     2004               2003
                                                     ----               ----
          Office furniture and equipment         $   146,690        $   140,475
          Computer equipment                       1,960,797          1,747,454
          Demonstration equipment                        ---              7,726
          Leasehold improvements                     246,077            231,915
                                                 -----------        -----------
                                                   2,353,564          2,127,570
          Less:  Accumulated depreciation         (1,996,512)        (1,742,405)
                                                 -----------        -----------
                                                 $   357,052        $   385,165
                                                 ===========        ===========

          Depreciation and amortization  expense of $272,769 and $239,878 on the
          above assets was  recorded  for the years ended  December 31, 2004 and
          2003, respectively.

          In 2004,  the Company  disposed of $16,314 of computer  equipment  and
          $7,727 of  demonstration  equipment.  In 2003, the Company disposed of
          $117,189  of  demonstration   equipment  and  transferred  $17,020  of

                                       46
<PAGE>


          computer  equipment  to  inventory  at net  book  value.  The  loss on
          disposal is included in other expense-net.


NOTE 5 -  GOODWILL AND OTHER TANGIBLE ASSETS:
          On January 1, 2002,  the Company  adopted SFAS No. 142,  "Goodwill and
          Other  Intangible  Assets."  Under  SFAS 142,  the  Company  will test
          goodwill for impairment on an annual basis, or whenever  indicators of
          impairment  are  identified.  The Company  completed the  transitional
          impairment test of goodwill during the quarter ended June 30, 2002 and
          concluded  that no  impairment  existed on  January 1, 2002,  when the
          standard was adopted.  Management considers the Company's quoted stock
          price  to be  the  best  indicator  of  fair  value  for  purposes  of
          performing these analyses.

          Based on the decline of the  Company's  stock price  during the second
          and third  quarters of 2002,  however,  the fair value was  recomputed
          using the quoted quarter-end stock prices. Such computations  resulted
          in goodwill  impairment charges of $3,000,000 and $5,500,000  recorded
          as operating expenses during the respective 2002 quarters. The Company
          continues to monitor goodwill for potential impairment.

          Amortization  of  other  intangible  assets  has  been  immaterial  to
          operating results to date.


NOTE 6 -  NOTES PAYABLE:
          First Laurus Convertible Note:
          On July 31,  2003,  the Company  entered  into a  Securities  Purchase
          Agreement ("the Agreement") with Laurus Master Fund, Ltd.  ("Laurus").
          Pursuant to the Agreement,  the Company issued to Laurus a Convertible
          Note ("Note") in the principal amount of $2,000,000 that bore interest
          at the prime rate plus 1.25% (subject to a floor of 5.25%) and matured
          on July 31, 2005.

          During  November and December 2003,  Laurus  converted  $85,250 of the
          Note into 55,000 shares of Nestor common stock at $1.55 per share.  On
          January  14,  2004,  the  Company   satisfied  its  remaining  payment
          obligations on the Note by issuing  492,904 shares of its common stock
          to  Laurus  at the  fixed  conversion  price of $1.55  per  share  and
          redeeming  the  remaining  $1,150,750  note  balance by a "payment" of
          $1,340,972,  which included accrued interest and a $172,613 prepayment
          penalty.  This  "payment"  was netted  against the  proceeds  from the
          Second Laurus  Convertible Note (see below),  resulting in $98,028 net
          cash proceeds to the Company.

          The  note  was  collateralized  by  a  first  lien  on  all  available
          CrossingGuard,  Inc. assets. Laurus had a general security interest in
          four customer contracts assigned by NTS to CrossingGuard, Inc. and NTS
          had pledged the common stock of CrossingGuard, Inc. In connection with
          financing,  Laurus  was  paid a fee of  $80,000,  had  certain  of its
          expenses  reimbursed and received a warrant to purchase 140,000 shares
          of the  Company's  common  stock.  The warrant  exercise  price was as
          follows:  $1.78  per share for the  purchase  of up to 83,000  shares;
          $1.94 per share for the purchase of an additional  33,000 shares;  and
          $2.25 per share for the purchase of an additional 24,000 shares. These
          warrants were exercised on a cashless  basis during the  quarter-ended
          September 30, 2004,  resulting in the Company issuing 76,466 shares of
          its common stock at a conversion price of $4.18 per share.

          Also in connection  with  financing,  Management  Services  Group/Sage
          Investments,  Inc.  ("Sage")  was paid a fee of $80,000  and  received
          $4,444 per month for nine  months for  continuing  consultation.  Sage
          received  warrants  to  purchase  14,000  shares of  Company  stock as
          follows: $1.78 per share for the purchase of up to 8,300 shares; $1.94
          per share for the purchase of an additional  3,300  shares;  and $2.25
          per share for the purchase of an additional  2,400 shares.  During the
          period  June  through  August  2004,  Sage  exercised  11,720 of these
          warrants on a cashless  basis,  resulting in the Company issuing 5,953
          shares of stock at conversion  prices of $3.54 to $4.46 per share. The
          warrant expiration date is July 31, 2008.

                                       47
<PAGE>


          The  Black-Scholes  values of the warrants  issued in connection  with
          this financing  totaled $143,980  (Laurus) and $14,398 (Sage) and were
          recorded as additional  paid-in capital.  The Laurus warrant value was
          recorded as a discount on the note  payable.  During the quarter ended
          September 30, 2003, the Company  amortized  $11,998 of the discount as
          interest  expense.  As the Note was satisfied on January 14, 2004, the
          remaining  unamortized  discount  of  $113,984,  deferred  interest of
          $55,148  and  deferred  financing  fees  of  $131,228  had  negligible
          continuing value and were consequently written off to interest expense
          (discount and deferred interest) and financing fees, respectively,  at
          December 31, 2003.

          Second Laurus Convertible Note:
          On January  14,  2004,  the Company  also  entered  into a  securities
          purchase  agreement  with  Laurus.  Pursuant  to that  agreement,  the
          Company  issued  to  Laurus a new  convertible  note in the  principal
          amount of  $1,500,000  that bore interest at the prime rate plus 1.25%
          (subject  to a floor of 5.25% per year) and  matured  on  January  14,
          2006.  Principal  repayments  commenced May 2004 with $195,000 paid in
          cash. In  conjunction  with this  transaction,  Sage received a fee of
          $60,000  and an  affiliate  of Laurus  received  a  management  fee of
          $45,000  and  reimbursement  of  certain  expenses.  The  first  lien,
          security  interest and pledge of  CrossingGuard,  Inc.  stock from the
          first Laurus Note continued to this second note.

          During September 2004,  Laurus converted $60,000 due on this note into
          17,143  shares  of Nestor  common  stock at $3.50  per  share.  Laurus
          subsequently  converted their  remaining  $1,245,000 note balance into
          355,714  shares of Nestor  common stock  during the period  October to
          November 3, 2004.

          Silver Star Convertible Note:
          On October 15, 2003,  the Company sold a $2,000,000  convertible  note
          ("Silver Star Note") to Silver Star  Partners I, LLC ("Silver  Star").
          The Silver Star Note was due on January 15, 2004 and bore  interest at
          the rate of 7% per year. On December 31, 2003,  the Company  exercised
          its option to satisfy  the Silver  Star note and  accrued  interest by
          issuing 676,384 shares of Nestor common stock at $3.00 per share.  See
          Common and Preferred Stock footnote also.

          Silver Star has the right to require the Company to register  with the
          SEC Silver Star's resale of all shares of common stock that it owns as
          soon as practicable after Silver Star requests that registration.  The
          Company  is  obligated  to  pay  all  expenses  associated  with  that
          registration.  The Company has other  obligations  in connection  with
          that registration,  including causing the registration statement filed
          to remain  continuously  effective  until the  distribution  of shares
          covered by the  registration  statement is complete  and  indemnifying
          Silver Star from  liabilities  it may incur  resulting from any untrue
          statement or omission of a material fact in the registration statement
          and  related  documents  and from  other  liabilities  related  to the
          registration.  Danzell  Investment  Management,  Ltd.  received  a  3%
          finders fee from the Company in connection with the Silver Star Note.

          William B. Danzell is the Chief Executive Officer of Nestor, Inc., the
          President  of Danzell  Investment  Management,  Ltd.  and the Managing
          Director of Silver Star Partners I, LLC. David N. Jordan and George L.
          Ball,  directors of Nestor,  are each also  affiliates  of Silver Star
          Partners  I, LLC.  Robert M.  Krasne  and  Stephen H.  Marbut,  former
          directors of Nestor,  are also  affiliates  of Silver Star Partners I,
          LLC. The sale of the note by Nestor to Silver Star Partners I, LLC and
          the  satisfaction of our obligations  under it by issuing common stock
          were  approved by the directors of Nestor not  affiliated  with Silver
          Star Partners I, LLC.

NOTE 7 -  PRIVATE PLACEMENT OF SENIOR CONVERTIBLE NOTES:
          In  November  2004,  the  Company  completed  the  sale of  $6,000,000
          aggregate  principal  amount  of its 5% Senior  Convertible  Notes due
          October  31,  2007  (the  "Senior  Convertible  Notes")  in a  private
          placement.  The Company  received  $5,555,000 of note  proceeds  after
          $445,000  of  placement   fees  and  related   expenses.   The  Senior
          Convertible  Notes are  convertible  into Nestor  common  stock at the
          option of the  investors at $5.82 per share and accrue  interest at 5%
          per year. The Company must make quarterly interest-only payments until


                                       48
<PAGE>


          the Senior  Convertible Notes are either paid in full or are converted
          into common stock.  At the option of the holders,  all amounts due may
          be accelerated upon certain events of default,  including  failures to
          pay  principal or interest when due,  breach of covenants  that remain
          uncured  after notice,  bankruptcy  of the Company or certain  similar
          events and defaults under other material credit arrangements.

          The Company may, at its option, redeem the Senior Convertible Notes in
          whole or in part,  at a  redemption  price of 105% before  November 1,
          2005, 102.5% before November 1, 2006, and 101% thereafter, plus unpaid
          interest,  upon 30 to 60 days prior  written  notice.  The  Company is
          obligated to offer to repurchase the Senior  Convertible  Notes at the
          then-current  redemption  price in the event of a change in control of
          the  Company  or upon the  occurrence  certain  financing  events,  as
          defined.  In connection with the Senior Convertible Notes, the Company
          issued a  warrant  to a  placement  agent for the  purchase  of 60,000
          shares of common stock at $5.21 per share exercisable  through October
          31, 2009.

          The  Securities  and Exchange  Commission  declared  the  Registration
          Statement  on Form S-2 (SEC  File No.  333-121015)  for the  resale of
          these shares  effective on January 28, 2005.  Pursuant to the terms of
          the  warrant,  the  Company  has agreed to  include  the resale of the
          shares of the Company's  common stock underlying the warrant in future
          registration  statements  upon  the  request  of such  holder.  During
          February 2005, two  noteholders  converted an aggregate  $600,000 note
          face value into 103,092 shares of Nestor stock at $5.82 per share. Any
          unamortized  deferred  financing  costs  associated with the converted
          notes will be expensed upon conversion.

NOTE 8 -  LEASES PAYABLE:
          On June 28, 2001, NTS executed a Master Lease Purchase  Agreement with
          Electronic Data Systems Corporation ("EDS"),  later amended on January
          10, 2003, whereby EDS provided lease financing to support installation
          of the NTS  CrossingGuard  product  to  municipalities  under  leasing
          terms. NTS received $3,183,180 in advances,  which were collateralized
          by equipment  delivered  under leased  CrossingGuard  systems.  During
          2003, the Company recorded $163,961 of EDS interest expense.  In 2002,
          the Company recorded $303,481 of EDS interest costs; $100,559 of which
          was capitalized as capitalized systems costs and $202,922 was expensed
          directly.

          On January 26, 2004, the Company  satisfied its remaining  obligations
          to EDS by making a payment of $2,178,764. This transaction resulted in
          the  Company  recording  a gain  on  early  extinguishment  of debt of
          $680,737 in January 2004.

NOTE 9 -  RESTRUCTURING:
          In June  2002,  the  Company  underwent  a  significant  restructuring
          involving  management  changes and cost control to lower personnel and
          facilities expenses as the Company refocused its efforts solely on its
          red-light video enforcement contracts for CrossingGuard installations.
          The  Company   terminated  19  full-time   employees,   affecting  all
          departments,  and offices were consolidated  into smaller  facilities.
          During  the  quarter  ended  June  30,  2002,  the  Company   recorded
          restructuring  costs (which are separately  disclosed in the Statement
          of Operations) of $743,000 primarily comprised of $332,000 in employee
          severance  agreements and estimated lease obligations  associated with
          closing its Providence,  RI and San Diego, CA offices. All obligations
          associated  with this  restructuring  reserve  were settled or paid in
          full in 2004.

NOTE 10 - ASSET RETIREMENT OBLIGATIONS:
          The Company's  video-based red light enforcement systems are installed
          at traffic  intersections under three to five year customer contracts.
          At  the  end  of  many  contracts,  NTS  is  required  to  remove  all
          aboveground structures and restore the site. At December 31, 2004, the
          Company has recorded a liability of $146,577 for this obligation.

                                       49
<PAGE>


NOTE 11 - COMMON AND PREFERRED STOCK:
          Private  Placement and Silver Star Note  Conversion:  The Company sold
          2,843,000  shares  of its  common  stock to  accredited  investors  in
          private placements  conducted during December 2003 (1,596,560 shares),
          and January 2004 (1,246,440 shares). The shares were sold at $3.00 per
          share,  with net proceeds to Nestor (after $682,000 of expenses of the
          offering)  of $2.76  per  share  totaling  $7,846,680  ($3,440,000  in
          January 2004).  The Securities  and Exchange  Commission  declared the
          Registration  Statement on Form S-2 (SEC File No.  333-112359) for the
          resale of these shares  effective  on April 23, 2004.  The Company has
          continuing  obligations  in connection  with the  registration  of the
          resale of the  shares  offered,  including  causing  the  registration
          statement filed to remain continuously  effective for two years or, if
          earlier,  until  the  sale  of  shares  covered  by  the  registration
          statement is complete and indemnifying the holders from liabilities it
          may  incur  resulting  from any  untrue  statement  or  omission  of a
          material fact in the registration  statement and related documents and
          from other liabilities related to the registration.

          On  December  31,  2003,  after the  initial  closing  of the  private
          placement above, the Company exercised its right to convert the Silver
          Star Note and accrued  interest  (see Note 6 also) by issuing  676,384
          shares of Nestor common stock at $3.00 per share.

          Although the proceeds from the initial  closing above were received in
          December  2003 and the  Silver  Star  note  conversion  was  effective
          December 31, 2003, the associated stock  certificates  were not issued
          until January 2004. As such,  these 2,272,944 shares are classified as
          "Stock Pending Issuance" on the balance sheet at December 31, 2003.

          Laurus Note Conversions:
          As more fully  described in Note 6, Laurus elected to convert  $85,250
          of their first note into 55,000 shares of Nestor common stock in 2003.
          In January 2004,  Laurus further  converted  $764,000 of the note into
          492,904 shares of Nestor common stock. Both conversions were priced at
          $1.55 per share. During the period September through November 3, 2004,
          Laurus converted $1,305,000 due on its second note into 372,857 shares
          of Nestor common stock at $3.50 per share.

          Silver Star Equity Financing:
          In a first  closing on January  15,  2003,  Silver Star  purchased  49
          million  shares of Nestor common stock  (pre-reverse  stock split) for
          $2,376,500  and  on  April  16,  2003,  completed  a  second  closing,
          purchasing an additional  4,013,557 shares  (post-reverse stock split)
          for $1,946,575.  Danzell Investment Management, Ltd., in which William
          B. Danzell, the Managing Director of Silver Star, serves as president,
          has  provided   investment-related   services  (including   consulting
          services) to the Company and has received a fee for services  rendered
          in an amount equal to 3% of the cash proceeds generated by the Company
          in connection with the financing  transactions  with Silver Star. Upon
          completion of the second closing,  Silver Star owned 64% of the issued
          and  outstanding  shares of Company  common  stock (51.4% and 63.7% at
          December 31, 2004 and 2003, respectively). See Form 8-K dated April 9,
          2003 for further information.

          One-for-Ten Reverse Stock Split:
          The Company filed a  certificate  of amendment to its  certificate  of
          incorporation on April 11, 2003,  causing a one-for-ten  reverse stock
          split of the outstanding  shares of the Company common stock effective
          on that date.  The  Company's  common  stock  began  trading on a post
          reverse  split basis on April 21,  2003 under the new  trading  symbol
          "NESO" (previously "NEST").  These financials reflect common stock and
          loss per share on a post-split basis.

          Preferred Stock:
          Series B Convertible  Preferred Stock is convertible into Common Stock
          of the  Company  at any  time on a  share-for-share  basis.  Series  B
          Convertible Preferred Stock has the same rights with respect to voting
          and dividends as the Common Stock,  except that each share of Series B
          Convertible  Preferred  Stock  has  the  right  to  receive  $1.00  in
          liquidation  before any  distribution is made to holders of the Common


                                       50
<PAGE>


          Stock.  The  liquidation  value of Series B Preferred  was $180,000 at
          December 31, 2004 and $190,000 at December 31, 2003.


NOTE 12 - OPTIONS AND WARRANTS:
          On April 1, 1984, the Company  adopted an Incentive Stock Option Plan,
          which  authorized  the  grant  of  options  for up to  245,000  shares
          (post-reverse   split)  of  the  Company's  common  stock.  This  plan
          terminated April 1, 2004.

          On May 6, 1997,  the Company  adopted the 1997 Stock Option Plan under
          which the Board of Directors granted incentive or non-qualified  stock
          options to employees,  directors and consultants to purchase shares of
          the Company's common stock at a price equal to the market price of the
          stock at the date of grant.  In June 2001,  the 1997 Stock Option Plan
          was amended to increase the aggregate number of options  authorized to
          500,000  shares  (post-reverse  split) of the Company's  common stock.
          Options vest over four years and are  exercisable  for up to ten years
          from the date of grant,  although most options  currently  outstanding
          expire  eight  years  from  the date of  grant.  The  options  are not
          transferable  except by will or domestic  relations  order. No further
          grants may be made under this Plan  pursuant  to the  adoption  of the
          2004 Stock Incentive Plan.

          On June 24, 2004, the Company  adopted the 2004 Stock  Incentive Plan,
          which  provides  for the grant of awards to  employees,  officers  and
          directors.  Subject to adjustments for changes in the Company's common
          stock and other  events,  the stock plan is  authorized to grant up to
          4,500,000  shares,  either in the form of options to  purchase  Nestor
          common stock or as  restricted  stock  awards.  The Board of Directors
          will  determine  the award  amount,  price usually equal to the market
          price of the stock on the date of the grant,  vesting  provisions  and
          expiration  period  (not to  exceed  ten  years)  in  each  applicable
          agreement.  The awards are not transferable except by will or domestic
          relations order.

          The  following  table  presents  the activity of the  Company's  Stock
          Option Plans for the years ended  December 31, 2004,  2003 and 2002 on
          post-reverse  split  basis.  The  number of options  canceled  in 2002
          included  unexercised  options  previously  held by employees who were
          terminated in connection  with the Company's  restructuring.  In 2003,
          options  granted were to directors of the Company;  many of which were
          canceled  later in 2003 due to  changes  in the  Board.  The number of
          options  granted and  outstanding  in 2004 rose  significantly  due to
          grants made pursuant to employment agreements (see Note 20) as well as
          grants made to each employee and director during the year.
<TABLE>
<CAPTION>

                                                                     Years Ended December 31,
                                              ---------------------------------------------------------------------
                                                       2004                   2003                2002
                                                       ----                   ----                ----

                                                         Weighted               Weighted                   Weighted
                                                          Av. Ex.                Av. Ex.                    Av. Ex.
                                                Shares     Price       Shares     Price           Shares     Price
                                              -------------------     ------------------        -------------------

<S>                                            <C>         <C>          <C>       <C>              <C>       <C>
          Outstanding beginning of year          312,397   $ 5.75       324,199   $ 6.50           395,121   $ 7.10
          Granted                              2,777,650     4.66       176,250     3.34            36,800     2.00
          Exercised                               28,000     1.34           ---      ---               ---      ---
          Canceled                               174,392     6.28       188,052     4.85           107,722     7.10
                                              ----------               --------                    --------
          Outstanding end of year              2,887,655   $ 4.71       312,397   $ 5.75           324,199   $ 6.50
                                              ==========               ========                    ========

          Options exercisable at year end      1,010,236   $ 4.87       233,970   $ 6.80           224,730   $ 7.30
                                              ==========               ========                    ========
</TABLE>

                                                              51
<PAGE>

          The  following  table  presents   weighted   average  price  and  life
          information  about significant  option groups  outstanding at December
          31, 2004:

<TABLE>
<CAPTION>
                                           Options Outstanding                      Options Exercisable
                              -----------------------------------------        ----------------------------
                                                Weighted
                                                 Average       Weighted                           Weighted
                                Number          Remaining       Average          Number           Averaged
            Range of          Outstanding      Contractual     Exercise        Exercisable       Exercisable
         Exercise Prices      at 12/31/04     Life (Years)       Price         at 12/31/04          Price
         ----------------     -----------     ------------     --------        -----------       -----------
<S>      <C>       <C>           <C>               <C>          <C>                <C>             <C>
         $ 1.00 -  $ 1.90        28,550            5.41         $  1.77            18,230          $  1.77
         $ 3.55 -  $ 3.85       344,400            4.02            3.76            92,000             3.80
         $ 4.50 -  $ 5.50     2,463,243            8.35            4.82           856,276             4.90
         $ 6.00 -  $10.20        46,462            1.24            6.47            38,730             6.54
         $15.00 -  $28.90         5,000            0.85           17.60             5,000             8.80
                              ---------            ----         -------          --------          -------
                              2,887,655            7.68         $  4.71         1,010,236          $  4.87
                              =========            ====         =======         =========          =======
</TABLE>


          The Company, at the discretion of the Board of Directors,  has granted
          warrants from time to time,  generally in conjunction with the sale of
          equities.  The Company issued 154,000  warrants in connection with the
          first  Laurus  note  financing  in July 2003 and  60,000  warrants  in
          connection with the private  placement in November 2004. The following
          table presents warrants  outstanding after adjusting to a post-reverse
          split basis:

                                                   Years Ended December 31,
                                          --------------------------------------
                                               2004          2003        2002
                                               ----          ----        ----
          Eligible, end of year for
            exercise currently                80,611        660,936      532,141
                                            ========      =========    =========

          Warrants issued                     60,000        154,000          ---
            Low exercise price             $    0.49      $    1.78    $     ---
            High exercise price            $    2.72      $    2.25    $     ---

          The  warrants  outstanding  as of  December  31,  2004  are  currently
          exercisable  and expire at various dates through October 31, 2009. The
          outstanding warrants entitle the owner to purchase one share of common
          stock for each  warrant,  at prices  ranging  from  $4.80 to $5.21 per
          share.

          During the year ended June 30,  1996,  the  exercise  price of 100,000
          warrants  issued in the prior year was  reduced  from  $15.00 to $6.50
          (post-reverse  split). The Company recorded,  on a prorated basis, the
          $850,000  cumulative  expense  over the life of the  warrants  through
          August 1, 2004. Accordingly,  the Company recognized expenses totaling
          $62,000,  $106,000  and  $106,000 in 2004,  2003 and 2002.  During the
          quarter ended September 30, 2004, all warrants with an expiration date
          of August 1, 2004 were exercised on a cashless basis. This resulted in
          Company  issuing  136,292  shares of its  common  stock at  conversion
          prices from $3.98 to $4.28 per share in exchange for 269,856  warrants
          with  exercise  prices from $.49 to $2.65 per share.  The Company also
          reclassified  $850,000  related to these warrants and $375,000 related
          to other expired warrants from warrants to additional  paid-in capital
          on the balance sheet.

          Laurus  Master  Fund,  Ltd.  exercised  their  140,000  warrants  with
          exercise  prices  from $1.78 to $2.25 per share on a  cashless  basis,
          resulting in the Company  issuing 76,466 shares of its common stock at
          a  conversion  price of $4.18 per share.  Sage also  exercised  11,720
          warrants  on a cashless  basis,  resulting  in the  issuance  of 5,953
          shares  of  Nestor  stock at  conversion  prices of $3.54 to $4.46 per
          share.

          In addition, NTS Investors, LLC (the "Group") received a warrant right
          in January 2001 to acquire up to 298,071  additional  shares of common
          stock  exercisable  at the same  price at which  the then  outstanding


                                       52
<PAGE>

          warrants of Nestor,  Inc. were exercisable,  but only in the event the
          then  outstanding  warrants were  exercised,  so as to maintain  their
          initial ownership interest percentage. This warrant right decreased by
          125,000  shares on March 1, 2002 with the expiration of TSAI's warrant
          on that date. The Group exercised 124,952 warrants on a cashless basis
          during  2004 at  prices  of $3.98 to $ 4.63 per  share,  resulting  in
          59,898 shares of Nestor stock being issued.  Warrants  outstanding  at
          December 31, 2004 includes 18,331 warrants  belonging to the Group. In
          addition,  the Group received a warrant to acquire  100,0000 shares of
          the  Company's  common  stock at $12.80  per share for three  years as
          dilution  protection  against both the Company's  and NTS's  converted
          employee stock options outstanding at closing. This warrant expired on
          September 12, 2004.  Such  remaining  warrants are treated as variable
          and, accordingly,  are revalued quarterly with offsetting  adjustments
          to additional paid-in capital.

NOTE 13 - SEGMENT INFORMATION:
          A.   Description of reportable segments
               The Company has two reportable segments:  Nestor, Inc. and Nestor
               Traffic Systems,  Inc. Nestor,  Inc. produced and sold credit and
               debit  card  fraud  detection  products  and  database  marketing
               products to financial  institutions  and  processors of financial
               data until the Company entered into reseller  license  agreements
               in 2001.  Subsequent  to the reseller  agreements,  Nestor,  Inc.
               revenues  were mainly  royalties  from these  licenses  until the
               Company  assigned its royalty  rights as of July 1, 2002. The NTS
               segment provides video-based  monitoring systems and services for
               traffic  safety,  mainly  to  municipalities.  Goodwill  has been
               allocated to the NTS segment.

          B.   Measurement of segment profit or loss and segment assets
               The Company evaluates  performance based on income or loss before
               investment  income  (loss).   The  accounting   policies  of  the
               reportable  segments are the same as those described elsewhere in
               these financial statements.

          C.   Segment income or loss and segment assets
               All  revenues  are  from   external   customers.   There  are  no
               intercompany sales.

<TABLE>
<CAPTION>

                                                              Nestor Traffic
                                             Nestor, Inc.      Systems, Inc.         Totals
                                             ------------     --------------         ------
               <S>                          <C>              <C>                <C>
               Year Ended
               December 31, 2004:
               Revenues                     $     37,000     $   5,998,000      $   6,035,000
               Segment net loss               (1,416,000)       (3,057,000)        (4,473,000)
               Segment assets                  7,148,000        11,699,000         18,847,000

               Year Ended
               December 31, 2003:
               Revenues                     $     29,000     $   2,677,000      $   2,706,000
               Segment net income (loss)        (528,000)       (4,362,000)        (4,890,000)
               Segment assets                  5,702,000        10,597,000         16,299,000

               Year Ended
               December 31, 2002:
               Revenues                     $    665,000     $   1,457,000      $   2,122,000
               Segment income (loss)           3,591,000       (16,225,000)       (12,634,000)
               Segment assets                    598,000         8,603,000          9,201,000
</TABLE>

          D.   Geographic Information
               All  revenues  are derived  from  United  States  customers.  All
               long-lived assets are located in the United States.

                                       53
<PAGE>


          E.   Revenues from Major Customers

                                                  Years Ended December 31,
                                            ------------------------------------
                                               2004          2003          2002
                                               ----          ----          ----

               Customer A - NTS             $1,212,410    $     ---    $    ---
               Customer B - NTS              1,187,000      399,067         ---
               Customer C - Nestor, Inc.           ---          ---      629,569
               Customer D - NTS                    ---      406,670      266,751
               Customer E - NTS                    ---      348,143      150,331
               Customer F - NTS                    ---          ---      293,911


NOTE 14 - IMPAIRMENT CHARGE:
          During the quarter ended June 30, 2002,  the Company  determined  that
          potential citation revenues from certain  CrossingGuard  installations
          in two cities  would not exceed  the cost of the  underlying  carrying
          value of the capitalized  systems.  These contracts were signed in the
          early  stages  of  CrossingGuard  development  and the site  selection
          procedures and contract terms have since been improved.  In accordance
          with SFAS No.  144,  "Accounting  for the  Impairment  or  Disposal of
          Long-Lived Assets",  the Company wrote off capitalized systems cost of
          $794,000 and recorded a corresponding  impairment  charge in operating
          expenses.  Ongoing revenues from these  installations  are expected to
          offset future costs of system operations.


NOTE 15 - ROYALTY ASSIGNMENT:
          On  July  15,  2002,   the  Company   entered  into  a  Memorandum  of
          Understanding  ("MOU") with  Churchill Lane  Associates,  LLC ("CLA"),
          assigning CLA certain of the Company's  rights to royalty income under
          a  previous  license.  CLA is owned  and  controlled  by three  former
          directors  and  shareholders  of the Company.  The MOU also provided a
          schedule  for  advances  by CLA to provide  interim  financing  to the
          Company  during  the  period  prior to the  closing.  Upon  closing on
          September  30,  2002,  CLA paid the Company $3.1 million in cash (less
          advances) for the  irrevocable  assignment of its royalty rights under
          the ACI License from July 1, 2002 and in perpetuity. No obligations or
          other rights of the Company were transferred or assigned to CLA.

          After offsetting  $860,000 of ACI unbilled contract revenue,  $632,000
          of ACI deferred income and $60,000 in related  professional  fees, the
          Company  recorded a  $2,812,000  gain on this  royalty  assignment  on
          September 30, 2002. The elimination of ACI unbilled  contract  revenue
          and deferred income were recorded as non-cash reductions.



NOTE 16 - MASTER LEASE ASSIGNMENT:
          The State of Delaware Department of Transportation (DelDOT) executed a
          Master  Lease  Agreement  with  NTS in  February  2004  whereby  lease
          financing for equipment  installed under this  CrossingGuard  contract
          would be  financed  under  lease  terms  offered by GE Capital  Public
          Finance,  Inc.  ("GE").  Under this sales-type  lease  agreement,  NTS
          received  $240,000 on April 27, 2004,  $240,000 on September 17, 2004,
          and $400,000 on December 31, 2004 from GE on behalf of DelDOT pursuant
          to its Assignment and Security  Agreement with GE. NTS retains a first
          priority  interest in the  equipment  and assigned its interest in the
          DelDOT lease and right to receive rental payments thereunder to GE. As
          a matter of convenience,  NTS monthly billings to DelDOT include their
          GE repayment of principal and interest, which NTS then remits to GE on
          their behalf.

                                       54
<PAGE>


NOTE 17 - OTHER EXPENSE - NET:

          Other  expense  as  reflected  in  the   consolidated   statements  of
          operations consists of the following:

                                                   Years Ended December 31,
                                            ------------------------------------
                                                2004        2003         2002
                                                ----        ----         ----

          Interest and dividend income      $  78,990    $  13,438    $  11,229
          Interest expense                   (239,282)    (470,206)    (217,023)
          Expense relating to financing
            operations                        (62,115)    (106,484)    (106,483)
          Unrealized loss                      (9,963)         ---          ---
          Realized loss                       (96,367)         ---          ---
          Other income                            ---       64,130          ---
          Loss on disposal of fixed assets     (5,378)      (5,291)      (6,341)
                                            ----------   ---------    ---------
          Other expense - net               $(334,115)   $(504,413)   $(318,618)
                                            ==========   =========-   =========

NOTE 18 - INCOME TAXES:
          During  2004 and  2003,  the  Company  recorded  deferred  tax  assets
          primarily  for the  benefit of net  operating  losses in the amount of
          $2,697,000 and  $1,742,000,  respectively.  The  cumulative  amount of
          these assets,  which is  $17,469,000  and  $16,514,000 at December 31,
          2004 and 2003,  respectively,  is fully reserved. Due to the Company's
          history of operating losses, management has concluded that realization
          of the benefit is not likely.

          The Company  has  available  at December  31,  2004,  $44,771,000  and
          $28,402,000 of net operating loss  carryforwards for federal and state
          purposes,  respectively.  Approximately  $13,318,000 and $9,960,000 of
          these federal and state net operating loss carryforwards were acquired
          as part of the  merger  with  NTS.  These  loss  carryforwards  may be
          applied against future taxable income and begin to expire in 2005.

          Pursuant to Section 382 of the Internal  Revenue  Code,  annual use of
          the tax loss  carryforwards  may be  limited  if there is a change  in
          ownership.  This limitation  applies to the losses incurred by Nestor,
          Inc.,  as well as to the losses  incurred by NTS. The use of state net
          operating losses may be limited in the future due to the apportionment
          of net  operating  losses  among  different  states  and  varying  net
          operating loss utilization  requirements by state. The Company has not
          determined the effect of these limitations.


NOTE 19 - RELATED PARTY TRANSACTIONS:
          Benjamin Alexander, secretary of the Company (as of June 2003), was an
          attorney  with the firm of  Partridge,  Snow and Hahn  LLP,  which the
          Company uses for legal services. For the years ended December 31, 2004
          and 2003, the Company  recorded legal and stockholder  expenses to Mr.
          Alexander's  firm in the amounts of  $133,367  and $0, and $63,973 and
          $24,354, respectively. Also, in 2004, $44,300 was recorded relating to
          the senior  convertible  note,  $11,656  relating to the January  2004
          Laurus financing,  and $41,752 was recorded against amounts accrued in
          prior years.  Other 2003 payments include $11,261 recorded relating to
          the July 2003 Laurus financing. All Laurus financing amounts have been
          fully expensed. As of February 28, 2005, Mr. Alexander became salaried
          general counsel to the Company, retaining his title of secretary.

          On January 1, 1999,  Nestor,  Inc.  entered into an exclusive  license
          with  NTS  through  the  expiration  date  of the  underlying  patents
          protecting  the  technologies  used in  NTS's  products.  The  license
          provides for royalties,  as defined,  to be paid to Nestor,  Inc. that
          are eliminated in consolidation.

          Deferred  compensation  of $79,131  was  recorded  and accrued for the
          period  July 1, 2002 to  December  31,  2002 for two  officers  of the
          Company. The deferral was paid in full January 2003.

          See Note 6 for  transactions  with  Silver Star and Laurus and Note 15
          for royalty assignment to Churchill Lane Associates, LLC.

                                       55
<PAGE>



NOTE 20 - COMMITMENTS AND CONTINGENCIES:
          NTS entered into an operating lease dated June 21, 2000 for office and
          warehouse  facilities in East  Providence,  Rhode  Island.  This lease
          provides  for monthly  rentals of $10,360  through  July 2003 and then
          increased to $10,800  monthly through July 2005. Rent expense for this
          lease was  $124,300 in 2002,  $126,500 in 2003,  and $139,129 in 2004.
          Space  was  leased  adjacent  to  this  facility  in  July  2004,  for
          additional  office and warehouse  facilities.  This lease provides for
          monthly rentals of $5,400 through May 2005 then increases $200 monthly
          in each of the two  following  years.  Rent expense for this lease was
          $40,108 in 2004.

          NTS also leases office space in San Diego,  California.  The July 2004
          operating  lease  calls for monthly  rent of $2,627  through the lease
          term expiration of June 2006. Rent expense was $14,576 in 2004.

          The Company also leases warehouse space in Placentia,  California. The
          February 2004 operating lease calls for monthly rent of $1,398 through
          the lease term expiration of January 2006. Rent expense was $15,378 in
          2004.

          On  October  13,  2004,  the Board of  Directors  approved  employment
          agreements  for  the  Company's  Chief  Executive  Officer  and  Chief
          Operating   Officer   through   December  31,  2007.   The  agreements
          automatically  renew for a two-year  period unless the Company  elects
          not to renew.  The  agreements  provide  for a base salary of not less
          than  $250,000  (CEO)/$200,000  (COO)  and  annual   performance-based
          bonuses to be determined by the Company's Compensation Committee.  The
          Company also granted  1,000,000  stock  options to the CEO and 600,000
          stock options to the COO pursuant to the  employment  agreements.  See
          Form 8-K dated October 13, 2004 for further information.  On March 25,
          2005,  the COO's  position  changed to  Executive  Vice  President  of
          Nestor, Inc. and his compensation remains unchanged.

          Further,  in March  2005 the Board of  Directors  approved  employment
          agreements for a new Chief Operating  Officer and a Vice President and
          General  Counsel  of Nestor,  Inc.  through  December  31,  2008.  The
          agreements  automatically renew for one year unless the Company elects
          not to renew.  The  agreements  provide  for a base salary of not less
          than  $175,000  (COO)/$165,000  (Counsel)  and the COO is  entitled to
          receive  performance-based  cash and options bonuses, as defined.  The
          Company also granted 30,000 stock options to the COO and 135,000 stock
          options to Counsel pursuant to the employment agreements.  See Item 9B
          to this annual report for further information.

          The Company has two customers  operating  photo red light  enforcement
          programs under Virginia  General Assembly  authority,  which currently
          ends July 1, 2005.  Many bills to extend  the photo red  program  have
          been defeated,  despite significant program support. If the program is
          not extended, one customer contract will terminate  prematurely,  with
          approximately  $194,000  of  undepreciated  costs  at  July  1,  2005.
          Contract renewal discussions with the other customer are on hold until
          program authorization is extended.

NOTE 21 - LITIGATION:
          On November  6, 2003,  the  Company  filed a  complaint  in the United
          States  District  Court  for  Rhode  Island  against  Redflex  Traffic
          Systems, Inc., alleging that Redflex's automated red light enforcement
          systems  infringe  on  the  Company's  patent.   Redflex  denies  this
          allegation. On November 25, 2003, the Company filed a complaint in the
          United States  District  Court for the District of Central  California
          against Transol USA, Inc., alleging that Transol's automated red light
          enforcement  systems  infringe on the  Company's  patent.  Transol has
          counterclaimed  that Nestor's  patent is invalid and that Transol does
          not infringe on it. Nestor was denied a preliminary  injunction in the
          Transol litigation.

          On July 13,  2004,  the  Company  filed a second  lawsuit  for  patent
          infringement  against Redflex Traffic  Systems,  Inc. but subsequently
          withdrew this claim without prejudice. In addition, Nestor amended its
          pending  lawsuit  against Transol USA, Inc., to assert like claims for
          patent infringement. The additional lawsuit filed against Redflex, and

                                       56
<PAGE>
          the amended claims asserted  against Transol,  allege  infringement of
          U.S.  Patent No.  6,754,663,  issued to Nestor on June 22,  2004.  The
          original  lawsuit  against  Redflex is pending in US  District  Court,
          District of Rhode Island.

          The  lawsuit  against  Transol  is  pending  and  interrogatories  and
          depositions  have taken place.  On December 30, 2004,  Transol filed a
          motion for  summary  judgment  and partial  summary  judgment to which
          Nestor filed an opposition on January 27, 2005. In February  2005, the
          judge hearing the case voluntarily recused himself and a new judge was
          assigned.  A hearing on  Transol's  motion  for  summary  judgment  is
          scheduled for April 11, 2005.  The Company  cannot give assurance that
          it will be successful in either action.

          During April 2003, the former president of NTS resigned as a member of
          the board of directors of the Company. The president's employment with
          the  Company  and NTS  terminated.  The  president  filed a  complaint
          against the Company and NTS in the  Providence  Superior Court seeking
          severance benefits,  including twelve months salary of $180,000,  upon
          termination.  The parties reached a mutually  agreeable  settlement on
          December 31,  2003,  the terms of which are  confidential.  All claims
          have been dismissed.

          In the  ordinary  course of  business,  the Company is a defendant  in
          certain  claims and legal  proceedings.  In the opinion of management,
          the outcome of these  matters  will not have a material  effect on the
          financial position of the Company.


NOTE 22 - CONTRACT TERMINATION RESERVE:
          A  significant  customer  contract  in the Rail line of  business  was
          terminated by mutual  agreement prior to its completion as a result of
          the Company's decision to focus its resources on CrossingGuard systems
          and  services.  The Company  accrued  $125,000 of  estimated  contract
          termination fees in June 2003. Payment was satisfied in December 2004.


NOTE 23 - RECENT ACCOUNTING PRONOUNCEMENTS:
          In  December  2004,  the FASB  issued  SFAS No.  123  (revised  2004),
          "Share-Based  Payment".  SFAS 123 (revised 2004) requires companies to
          recognize in the statement of operations the grant-date  fair value of
          stock options and other equity-based  compensation.  That cost will be
          recognized  over the period  during  which an  employee is required to
          perform service in exchange for the award, usually the vesting period.
          Subsequent  changes in fair value during the requisite service period,
          measured at each reporting  date,  will be recognized as  compensation
          cost over the period.  SFAS 123  (revised  2004) is  effective  in the
          first  interim or annual  period  beginning  after June 15, 2005.  The
          Company will be required to adopt SFAS 123 (revised 2004) in its third
          quarter of 2005.  The Company is evaluating the impact of the adoption
          of SFAS 123 (revised  2004) on the  Company's  financial  position and
          results of operations.



                                       57
<PAGE>



                                                                        PART III

ITEM 10.  Directors and Executive Officers of the Registrant.
          --------------------------------------------------

          Incorporated  by  reference  from the  Company's  definitive  proxy or
          information  statement  to be filed with the  Securities  and Exchange
          Commission  not later than 120 days following the end of the Company's
          fiscal year.

          The Company has adopted a written  code of ethics that  applies to all
          employees,  including  but not  limited  to, its  principal  executive
          officer,  principal financial officer, principal accounting officer or
          controller,  or  persons  performing  similar  functions.  A  copy  of
          Nestor's  code of ethics is  available  without  charge by writing to:
          Nestor, Inc., 400 Massasoit Avenue, Suite 200, East Providence,  Rhode
          Island 02914-2020, Attention: Claire M. Iacobucci.


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

          Incorporated  by  reference  from the  Company's  definitive  proxy or
          information  statement  to be filed with the  Securities  and Exchange
          Commission  not later than 120 days following the end of the Company's
          fiscal year.


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

          Incorporated  by  reference  from the  Company's  definitive  proxy or
          information  statement  to be filed with the  Securities  and Exchange
          Commission  not later than 120 days following the end of the Company's
          fiscal year.


ITEM 13.  Certain Relationships and Related Transactions.
          ----------------------------------------------

          Incorporated  by  reference  from the  Company's  definitive  proxy or
          information  statement  to be filed with the  Securities  and Exchange
          Commission  not later than 120 days following the end of the Company's
          fiscal year.


ITEM 14.  Principal Accounting Fees and Services.
          --------------------------------------

          Incorporated  by  reference  from the  Company's  definitive  proxy or
          information  statement  to be filed with the  Securities  and Exchange
          Commission  not later than 120 days following the end of the Company's
          fiscal year.






                                       58
<PAGE>



                                                                         PART IV



ITEM 15.  Exhibits, Financial Statement Schedules and Reports on Form 8-K.
          ---------------------------------------------------------------

               (a)  The following documents are filed as part of this report:

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

                    (2)  All  schedules  have been omitted  because the required
                         information   is  not   applicable   or   because   the
                         information  required is  included in the  consolidated
                         financial  statements  or notes  thereto.

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

                         See Exhibit Index.

               (b)  Reports on Form 8-K:

                    On  October  18,  2004,  the  Corporation   filed  with  the
                    Securities and Exchange  Commission a current report on Form
                    8-K  dated  October  13,  2004  under  items  1.01 and 9.01,
                    reporting  employment  agreements  between Nestor,  Inc. and
                    William B. Danzell, and Nestor, Inc. and Nigel P. Hebborn.

                    On  November  12,  2004,  the  Corporation  filed  with  the
                    Securities and Exchange  Commission a current report on Form
                    8-K dated November 5, 2004 under items 1.01,  2.03, 3.02 and
                    9.01,  reporting  sale  of  $6,000,000  aggregate  principal
                    amount of its 5% Senior  Convertible  Notes to institutional
                    and accredited investors pursuant to a Note Agreement.



                                       59
<PAGE>



                                    SIGNATURE

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused the report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                  NESTOR, INC.
                                  (Registrant)

                                  /s/ William B. Danzell
                                  -------------------------------------------
                                  William B. Danzell, Chief Executive Officer


                                  /s/ Claire M. Iacobucci
                                  --------------------------------------------
                                  Claire M. Iacobucci, Chief Financial Officer

Date:  March 30, 2005

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
registrant and in the capacities and on the dates indicated.

    Signatures                        Title                     Date
    ----------                        -----                     ----


/s/ William B. Danzell
----------------------------
William B. Danzell             Chairman of the
                                Board of Directors,
                                President, and                   March 30, 2005
                                Chief Executive Officer

/s/ George L. Ball
----------------------------
George L. Ball                 Director                          March 30, 2005

/s/ James S. Bennett
----------------------------
James S. Bennett               Director                          March 30, 2005


/s/ Albert H. Cox
----------------------------
Albert H. Cox                  Director                          March 30, 2005


/s/ Terry E. Fields
----------------------------
Terry E. Fields                Director                          March 30, 2005


/s/ Robert G. Flanders, Jr.
----------------------------
Robert G. Flanders, Jr.        Director                          March 30, 2005


/s/ William J. Gilbane, Jr.
----------------------------
William J. Gilbane, Jr.        Director                          March 30, 2005


/s/ David N. Jordan
----------------------------
David N. Jordan                Director                          March 30, 2005


/s/ Donald R. Sweitzer
----------------------------
Donald R. Sweitzer             Director                          March 30, 2005



                                       60
<PAGE>



                                INDEX OF EXHIBITS
                                -----------------


Exhibit No.         Description of Exhibit

   3.1              Restated Certificate of Incorporation.

   4.1              Specimen  Certificate  for shares of Common Stock,  $.01 par
                    value,  of  the  Registrant  filed  as  Exhibit  4.1  to the
                    Company's  Registration  Statement  on Form  S-2  (File  No.
                    333-108432), filed September 2, 2003, is hereby incorporated
                    herein by reference.

  10.1              Asset Purchase  Agreement and License  Agreement between the
                    Company and National  Computer  Systems,  Inc.,  filed as an
                    Exhibit to the  Company's  Current  Report on Form 8-K dated
                    June 11, 1996, is hereby incorporated by reference.

  10.2              PRISM  Non-Exclusive  License  Agreement between the Company
                    and Applied Communications, Inc., filed as an Exhibit to the
                    Company's  Current  Report on Form 8-K dated  September  19,
                    1996, is hereby  incorporated by reference.  Portions of the
                    Exhibit  omitted,   pursuant  to  a  grant  of  confidential
                    treatment.

  10.3              License  Agreement  dated  as of  March  28,  1997,  between
                    Nestor,  Inc. and Total System  Services,  Inc.  filed as an
                    Exhibit to the  Company's  Current  report on Form 8-K dated
                    April 8, 1997, is hereby incorporated by reference. Portions
                    of the Exhibit omitted,  pursuant to a grant of confidential
                    treatment.

  10.4              Amendment to the PRISM Non-Exclusive License Agreement dated
                    as of April 18,  1997,  between  Nestor,  Inc.  and  Applied
                    Communications,  Inc.  filed as an Exhibit to the  Company's
                    Current  Report on Form 8-K dated  April 30,  1997 is hereby
                    incorporated  by reference.  Portions of the Exhibit omitted
                    pursuant to a grant of confidential treatment.

  10.5              Exclusive License Agreement between Nestor,  Inc. and Nestor
                    Traffic  Systems,  Inc.  dated  January  1, 1999 filed as an
                    Exhibit to the  Company's  Current  Report on Form 8-K dated
                    March 25, 1999.

  10.6              Secured Note  Agreement by and among  Nestor,  Inc.,  Nestor
                    Traffic Systems, Inc. and NTS Investors LLC dated January 9,
                    2001 and filed as an Exhibit to the Company's Current Report
                    on Form 8-K on January  18, 2001 is hereby  incorporated  by
                    reference.

  10.7              License  Agreement  between Nestor,  Inc. and ACI Worldwide,
                    Inc.  dated  February  1, 2001  filed as an  Exhibit  to the
                    Company's  Current Report on Form 8-K on February 9, 2001 is
                    hereby incorporated by reference.

  10.8              License Agreement dated May 18, 2001 between the Company and
                    Retail Decisions,  Inc. filed as an exhibit to the Company's
                    current report on Form 8K dated May 18, 2001 which is hereby
                    incorporated by reference.

  10.9              Security  Purchase  Agreement  dated July 31,  2003  between
                    Nestor,  Inc.  and  Laurus  Master  Fund,  Ltd.  filed as an
                    exhibit to the  Company's  current  report on Form 8-K dated
                    July 31, 2003, which is hereby incorporated by reference.

  10.10             Convertible Note dated July 31, 2003 made by Nestor, Inc. to
                    Laurus  Master  Fund,  Ltd.  filed  as  an  exhibit  to  the
                    Company's  current  report on Form 8-K dated  July 31,  2003
                    which is hereby incorporated by reference.

  10.11             Registration  Rights  Agreement  dated July 31, 2003 between
                    Nestor,  Inc.  and  Laurus  Master  Fund,  Ltd.  filed as an
                    exhibit to the  Company's  current  report on Form 8-K dated
                    July 31, 2003, which is hereby incorporated by reference.

  10.12             Common Stock Purchase  Warrant dated July 31, 2003 issued by
                    Nestor, Inc. to Laurus Master Fund, Ltd. filed as an exhibit
                    to the Company's  current  report on Form 8-K dated July 31,
                    2003 which is hereby incorporated by reference.

                                       61
<PAGE>


Exhibit No.         Description of Exhibit
-----------         ----------------------

  10.13             Stock Pledge  Agreement  dated July 31, 2003 between  Nestor
                    Traffic Systems,  Inc. and Laurus Master Fund, Ltd. filed as
                    an exhibit to the Company's current report on Form 8-K dated
                    July 31, 2003, which is hereby incorporated by reference.

  10.14             Pledge and  Security  Agreement  dated July 31, 2003 between
                    CrossingGuard, Inc. and Laurus Master Fund, Ltd. filed as an
                    exhibit to the  Company's  current  report on Form 8-K dated
                    July 31, 2003 which is hereby incorporated by reference.

  10.15             Guaranty  dated  July 31,  2003 by  CrossingGuard,  Inc.  to
                    Laurus  Master  Fund,  Ltd.  filed  as  an  exhibit  to  the
                    Company's  current  report on Form 8-K dated  July 31,  2003
                    which is hereby incorporated by reference.

  10.16             Nestor, Inc. Incentive Stock Option Plan, as amended,  filed
                    as an Exhibit to the  Company's  Registration  Statement  on
                    Form S-8, filed May 5, 1987, is hereby  incorporated  herein
                    by reference

  10.17             Nestor,  Inc. 1997 Incentive  Stock Option Plan, as amended,
                    filed as an Exhibit to the Company's  Registration Statement
                    on Form S-8, filed May 16, 1997, is hereby  incorporated  by
                    reference.

  10.18             Nestor Traffic Systems, Inc., Form of Subscription Agreement
                    dated March 25, 1999, to sell a 37.5% equity position in its
                    common  stock and issue a warrant  for an  additional  17.5%
                    common  stock  interest  filed  as an  Exhibit  to  Nestor's
                    Current  Report on Form 8-K dated  April 23,  1999 is hereby
                    incorporated by reference.

  10.19             Security  Purchase  Agreement dated January 14, 2004 between
                    Nestor,  Inc.  and  Laurus  Master  Fund,  Ltd.  filed as an
                    Exhibit  to  Nestor's  Current  Report  on  Form  8-K  dated
                    December 31, 2003 is hereby incorporated by reference.

  10.20             Convertible Note dated January 14, 2004 made by Nestor, Inc.
                    to Laurus Master Fund,  Ltd. filed as an Exhibit to Nestor's
                    Current Report on Form 8-K dated December 31, 2003 is hereby
                    incorporated by reference.

  10.21             Registration Rights Agreement dated January 14, 2004 between
                    Nestor,  Inc.  and  Laurus  Master  Fund,  Ltd.  filed as an
                    Exhibit  to  Nestor's  Current  Report  on  Form  8-K  dated
                    December 31, 2003 is hereby incorporated by reference.

  10.22             Redemption and Conversion  Agreement  dated January 14, 2004
                    between  Nestor,  Inc. and Laurus Master Fund, Ltd. filed as
                    an Exhibit to the Company's  Registration  Statement on Form
                    S-2,   as   amended   (File  No.   333-108432),   is  hereby
                    incorporated by reference.

  10.23             Placement  Agent  Agreement  dated  December  24, 2003 among
                    Nestor,  Inc.,  Sanders Morris  Harris,  Inc., and Barrett &
                    Company,   Inc.   filed  as  an  Exhibit  to  the  Company's
                    Registration  Statement  on Form S-2,  as amended  (File No.
                    333-108432), is hereby incorporated by reference.

  10.24             Registration  Rights Agreement dated December 31, 2003 among
                    Nestor,  Inc.,  Sanders Morris  Harris,  Inc., and Barrett &
                    Company,   Inc.   filed  as  an  Exhibit  to  the  Company's
                    Registration  Statement  on Form S-2,  as amended  (File No.
                    333-108432), is hereby incorporated by reference.

  10.25             Nestor,  Inc. 2004 Stock  Incentive Plan filed as an Exhibit
                    to Nestor's  Current  Report on Form 8-K dated June 24, 2003
                    and  filed  as an  Exhibit  to  the  Company's  Registration
                    Statement  on Form S-8 filed  January  21,  2005,  is hereby
                    incorporated by reference.

                                       62
<PAGE>



Exhibit No.         Description of Exhibit
----------          ----------------------

  10.26             Employment  Agreement dated October 13, 2004 between Nestor,
                    Inc. and William B. Danzell, filed as an Exhibit to Nestor's
                    Current Report on Form 8-K dated October 13, 2004, is hereby
                    incorporated by reference.

  10.27             Employment  Agreement dated October 13, 2004 between Nestor,
                    Inc. and Nigel P.  Hebborn,  filed as an Exhibit to Nestor's
                    Current Report on Form 8-K dated October 13, 2004, is hereby
                    incorporated by reference.

  10.28             Note  Purchase  Agreement  dated  November  5, 2004  between
                    Nestor,  Inc. and the purchasers named therein,  filed as an
                    Exhibit  to  Nestor's  Current  Report  on  Form  8-K  dated
                    November 5, 2004, is hereby incorporated by reference.

  10.29             Registration  Rights  Agreement dated November 5, 2004 among
                    Nestor,  Inc. and the purchasers named therein,  filed as an
                    Exhibit  to  Nestor's  Current  Report  on  Form  8-K  dated
                    November 5, 2004, is hereby incorporated by reference.

  10.30             Warrant to Purchase Common Stock,  issued by Nestor, Inc. to
                    Sanders Morris Harris, Inc. dated November 5, 2004, filed as
                    an  Exhibit  to  Nestor's  Current  Report on Form 8-K dated
                    November 5, 2004, is hereby incorporated by reference.

  10.31             Distributorship  Agreement by and between  Nestor,  Inc. and
                    Vitronics  Machine Vision,  Ltd. dated August 17, 2004 filed
                    as an Exhibit to Nestor's  Quarterly Report on Form 10-Q for
                    the quarter ended September 30, 2004, is hereby incorporated
                    by reference.

  10.32             Incentive Stock Option Agreement by and between Nestor, Inc.
                    and William B.  Danzell  dated  October 13, 2004 filed as an
                    Exhibit to  Nestor's  Quarterly  Report on Form 10-Q for the
                    quarter ended September 30, 2004, is hereby  incorporated by
                    reference.

  10.33             Incentive Stock Option Agreement by and between Nestor, Inc.
                    and William B.  Danzell  dated  October 13, 2004 filed as an
                    Exhibit to  Nestor's  Quarterly  Report on Form 10-Q for the
                    quarter ended September 30, 2004, is hereby  incorporated by
                    reference.

  10.34             Incentive Stock Option Agreement by and between Nestor, Inc.
                    and Nigel P.  Hebborn  dated  October  13,  2004 filed as an
                    Exhibit to  Nestor's  Quarterly  Report on Form 10-Q for the
                    quarter ended September 30, 2004, is hereby  incorporated by
                    reference.

  10.35             Incentive Stock Option Agreement by and between Nestor, Inc.
                    and Nigel P.  Hebborn  dated  October  13,  2004 filed as an
                    Exhibit to  Nestor's  Quarterly  Report on Form 10-Q for the
                    quarter ended September 30, 2004, is hereby  incorporated by
                    reference.

  10.36             Employment  Agreement  dated March 29, 2005 between  Nestor,
                    Inc. and Tadas A. Eikinas.

  10.37             Employment  Agreement  dated March 29, 2005 between  Nestor,
                    Inc. and Benjamin M. Alexander.

  10.38             Incentive Stock Option Agreement by and between Nestor, Inc.
                    and Tadas A. Eikinas dated March 29, 2005.

  10.39             Incentive Stock Option Agreement by and between Nestor, Inc.
                    and Benjamin M. Alexander dated March 29, 2005.

  10.40             Employment  Offer Letter to Harold A.  Joannidi from Nestor,
                    Inc. dated March 29, 2005.

  10.41             Bonus  Targets  Letter to William B. Danzell dated March 29,
                    2005.

  10.42             Bonus  Targets  Letter to Nigel P.  Hebborn  dated March 29,
                    2005.

  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

                                       63
<PAGE>


Exhibit No.         Description of Exhibit
-----------         ----------------------

  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

  32                Statement Pursuant to 18 U.S.C. ss.1350*














------------------------------------------------------------------------

*    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.




                                       64