UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K
(Mark One)
( X ) Annual Report  Pursuant to Section 13 or 15(d) of the Securities  Exchange
Act of 1934 For the fiscal year ended December 31, 2000

(   )Transition  Report  Pursuant  to  Section  13 or  15(d)  of the  Securities
Exchange  Act  of  1934  For  the   transition   period  from   ___________   to
__________________


Commission File No.                        0-5265
                    ------------------------------------------------------------

                                SCAN-OPTICS, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

               Delaware                                  06-0851857
------------------------------------             ------------------------
 (State or other jurisdiction of                     (I.R.S. Employer
  incorporation or organization)                  Identification Number)

169 Progress Drive, Manchester, CT                             06040
--------------------------------------------------------------------------------
(Address of principal executive offices)                     Zip Code

                                 (860) 645-7878
--------------------------------------------------------------------------------
              (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,
                                                              $.02 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 that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.
( X ) YES    (   ) NO
 ---          ---

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

The aggregate  market value of the voting stock (common) held by  non-affiliates
of the registrant: $1,785,536 as of March 21, 2001.

The number of shares of common stock,  $.02 par value,  outstanding  as of March
21, 2001 was 7,439,732



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<PAGE>

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement,  relating to the 2001 Annual Meeting
of  Stockholders,  which  will be  filed  pursuant  to  Regulation  14A with the
Securities and Exchange  Commission not later than 120 days after the end of the
fiscal year, are incorporated by reference and included in the following:

Part III-Item 10 - Directors and Executive Officers of the Registrant
Part III-Item 11 - Executive Compensation
Part III-Item 12 - Security Ownership of Certain Beneficial Owners and
                   Management
Part III-Item 13 - Certain Relationships and Related Transactions
























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<PAGE>


                                     PART I

ITEM 1 - BUSINESS

Scan-Optics,  Inc. (the "Company") was  incorporated in Delaware in 1968 and has
its principal office at 169 Progress Drive, Manchester, Connecticut 06040.

The Company  designs,  manufactures,  markets and services  client/server  based
information-processing systems and software-based products that use state of the
art technology for imaging,  automated data capture,  document  management,  and
workflow.

The Company is a leader in applying  technology to solve information capture and
customer service challenges for government  agencies and commercial  businesses.
For 32 years,  the Company has provided  innovative  solutions to its customers,
using advanced technology for imaging and automated data capture.

The Company was among the first to develop Optical  Character  Recognition (OCR)
technology for data capture and is a leading  provider of image scanning systems
worldwide.  Building on its core  competencies  of  high-speed  paper  handling,
digital image  processing,  optical character  recognition,  and data entry, the
Company has  transitioned  to become a provider of  solutions  that focus on the
business needs of its customers.

The Company's  strategy is to provide a "Total Solution" to specific image, data
capture,  document  management  and  workflow  needs  within its chosen lines of
business.  This  allows  the  Company  to  position  itself  as a single  source
provider.

The  Company  has three  distinct  divisions:  Solutions  and  Products,  Access
Services and Manufacturing Services.

The Company's  Solutions and Products Division combines technology and expertise
to  develop  cost-effective   solutions  for  applications  in  the  government,
insurance,  transportation,  financial  and order entry  markets.  The Company's
ability to offer customized and integrated system solutions has helped customers
all over the world to meet their productivity and profitability objectives.

The Access Services Division of the Company provides third party and proprietary
maintenance services  nationwide,  as well as to the UK and Canada. The division
provides  hardware and software  maintenance  support for equipment and software
related to scanning,  imaging and automated data capture, as well as other forms
of electro-mechanical equipment.

Contract  Manufacturing,  a component of the  Company's  Manufacturing  Services
Division, formed in 1998 provides  electro-mechanical assembly and test services
for   equipment   such  as   large-format   scanners   and   other   large-scale
electro-mechanical devices.

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<PAGE>


SOLUTIONS AND PRODUCTS DIVISION

Solutions
The Company's solutions employ high speed document handling,  image capture, ink
jet printing,  character recognition,  multi-pocket document sorting, key-entry,
image storage and retrieval products,  as well as software/hardware  integration
services,  application  software  development  services,  and project management
services.

Scan-Optics'  TAXexpress(TM),  an automated  image-based tax processing and data
capture solution, consists of processing modules to handle income tax, sales tax
and other tax returns.  It applies the  technologies  of character  recognition,
data and image capture,  data correction,  and verification,  transfer to a host
system, image workflow,  and archive capabilities.  As a result,  TAXexpress(TM)
can  achieve  the  principal  goal  of  most  tax  and  revenue  departments  in
implementing an image-based tax processing system.

Scan-Optics'  ORDERexpress(TM) is an automated image-based data capture solution
for "club"  style  order  solicitation  and order  processing.  ORDERexpress(TM)
provides mark sense, machineprint, and handprint recognition, which are integral
parts of most reply  cards.  It also offers  processing  modules to handle order
reply cards, return non-orders,  and process payments.  This solution eliminates
the need to manually sort and separately process orders from non-orders and name
and address  changes.  Also available are hardware and  application  software to
process mail-out announcements, return order documents and payments.

Scan-Optics' PROOFexpress(TM) is an automated image-based solution for delivery,
data  capture,  and storage and  retrieval.  It provides  processing  modules to
process waybills,  delivery tickets, and other billing documents. It applies the
technologies of character  recognition,  data and image capture, data correction
and verification,  and transfer to a host system. As a result,  PROOFexpress(TM)
can achieve the principal goal of most billing  departments in  implementing  an
image-based storage and retrieval system.

Scan-Optics' ImageEMC++,  developed as a result of the Company's experience with
many of the nation's leading health insurance and other claim payment  companies
is a comprehensive  business solution designed to efficiently  process the paper
forms and other documents these organizations receive. It minimizes the time and
labor involved with processing single and multi-part health claims, enrollments,
and other forms, as well as correspondence,  re-pricing sheets and other general
documents.


Products
In June 1992, the Company  introduced  the Series 9000 scanner.  The Series 9000
integrates  the  latest  in  character  recognition,  image  capture,  and paper
handling  technology  into  a high  speed  scanner.  During  1993,  the  Company
introduced  several  options for this scanner.  These options  permit  character
recognition and image  processing on the "reverse side" of documents,  a special
small document  stacker module,  and the ability to recognize  several  industry
standard  bar-codes.  With the announcement of the 9000M (at 220ppm) in 2000 and
the 9000mm (at 100ppm) in 2001, the Company continues to lead in the high volume
document  processing  systems  market.  The 9000M and the 9000mm feature modular
design,  advanced  digital


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<PAGE>

camera  technology,  and black and white or  grayscale  output.  Both models are
based on  Windows  NT, and can  process  intermixed  forms of varying  sizes and
weights,  and both are available as simplex or duplex,  with an integrated image
quality monitor,  acoustic  double-detect  feeder,  and recognition  rates up to
10,000 characters per second.

In July 1996, the Company introduced a high-speed neural-network based handprint
recognition  system for use in the  Series  9000  scanner.  The  In-Line  Neural
Classifier  operates  at  speeds  of up to 7,500  characters  per  second  while
achieving a 50% reject rate reduction and 10%  substitution  rate reduction over
the previous handprint  recognition engine. The classifier is based on a special
neural network  algorithm that is resistant to  overtraining  making it an ideal
candidate for character recognition systems.

The Company  has been  involved in  leveraging  the power of neural  recognition
engines to achieve success with each application. The Company's patented Context
Edit  analyzes  data,  conducts  a  database  library  search,  compares  fields
character by character to locate a correct match, and then automatically updates
the data  batch  with the  correct  information.  With an  extensive  electronic
postal/name  library  virtually  every  combination  is considered  but only the
correct value is accepted.

The  Company  released  VistaCapture  in  1998.  VistaCapture  represents  a new
paradigm for creating data entry applications.  The VistaCapture  product suite,
an open-system  solution based on Microsoft's  VisualBasic,  utilizes  Microsoft
ActiveX (OCX)  technology.  VistaCapture  is designed for high-speed  key-entry,
key-from-image,    and   state-of-the-art    character   recognition   (OCR/ICR)
applications.

During  1998,  the  Company  announced  the  7400  scanner.  This  scanner  is a
versatile,  efficient,  affordably  priced desktop  solution for businesses with
single or multiple locations,  each with its own data capture and forms scanning
requirements.  It can be used to add new scanning  capabilities  or to augment a
larger  solution and is ideal for  businesses  with low to mid range (40-70 ppm)
scanner needs.

In 1999, the Company announced a document  management tool with Internet access,
DocWise, which was acquired through a licensing agreement with Bluebird Systems.
DocWise provides an environment where users can capture,  index, secure,  store,
access,  distribute,  and use the information  contained in documents simply and
efficiently.

The Company  added a new scanner  series to its line in 1999,  the Vision Series
8000.  The Vision  Series  8000 is targeted at the  mid-range  requirements  for
scanning.  Rated at 100 ppm to 200 ppm, the Series 8000 scanner family  converts
large volumes of documents into compressed electronic images.

In 2000,  Gray Scale  Optical Mark Read  (GSOMR) was released  which is a patent
pending  product  with   capabilities  to  more  accurately  detect  mark  sense
information for processing such forms as test scoring and balloting. The Company
intends to  continue  its  program of  development  of  additional  options  and
capabilities  for  its  existing  products  as well  as the  development  of new
products that take advantage of the Company's core competencies.



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<PAGE>

Core Competencies

Key  product  disciplines  utilize  integration  skills that  leverage  the core
competencies of the Company to provide broad solution  alternatives.  These core
competencies include:

Document Scanning
Image Enhancement Algorithms and Image Quality
Character Recognition (OCR, ICR, Barcode, Mark Sense, OMR, etc.)
Key-From-Image and Key-From-Paper Data Entry
Line of Business Domain Knowledge
Professional Services (Design, Development, Installation and Support)
Value Added Engineering Services and Solutions

Document Scanning
The Company has addressed the high-speed, high-volume,  page/document-processing
marketplace since its inception.  During 1992, the Company introduced the Series
9000 generation of scanners.  This was followed in 1998 with the 9000T. In 2000,
the Company  announced  the 9000M.  These  systems  provide  full-page  document
scanning,   including   options  for  front  and  back  imaging,   OCR  reading,
serialization, and sorting of documents in a single pass, black and white and/or
Grayscale output as standard components,  Windows NT platform,  resolutions from
200 to 400 dpi,  and  in-line  recognition  speeds up to 10,000  characters  per
second. In 1998, the Company introduced the Model 7400 scanner,  targeted at the
mid-volume  production market. In 1999, the Company added the Vision Series 8000
scanner  to its  line.  The  Series  8000  scanner  rated at 100 ppm to 200 ppm,
converts large volumes of documents into compressed electronic images.

Image Enhancement Algorithms and Image Quality
Image  enhancement  starts  at the  scanner  capture  system.  Various  embedded
algorithms are utilized to ensure a quality image is taken the first time. These
algorithms  include  code for  straightening  a page,  removing  black  "noise",
adjusting  the  contrast,  and  trimming  the  image  to the  exact  size of the
document.  The Company provides the fastest page capture and image system on the
market  today.  This  processing  is carried  forward  into the  Company's  OCR,
Key-From-Image and image storage and retrieval systems. Management believes that
the Company's image quality is among the best in the industry.  Electronic image
processing  and storage  are rapidly  overtaking  the use of  microfilm  and the
Company  is on the  leading  edge of  this  technology  with  its  hardware  and
application software solutions.

Character Recognition
The Company has developed and provided its own high-speed character  recognition
since 1968. OCR and its related technologies are able to lift data automatically
from  paper  forms,  without  the need for  manual  keying  of the data into the
computer  system.  The  Company's  recognition  technology  has always  included
in-line  recognition  of machine  printed,  handprinted  and mark  sense  forms.
In-line  recognition  occurs at very high speed,  in real-time,  as the paper is
moving down the scanning transport.

With the  introduction of the Series 9000 system,  the Company has expanded this
recognition to include  barcode,  patch code,  special  educational test scoring
analysis,  and special  stamp


                                       6
<PAGE>

recognition.  In  addition  to these  recognition  processes,  the  Company  has
integrated  and  developed  neural  recognition  technologies  that support both
in-line  and post  capture  recognition.  The  Company's  character  recognition
technology was enhanced in 1999 with its patented  Context Edit  capability that
brings a new level of data purification to the integrated solutions.

Key-From-Image and Key-From-Paper Data Entry
The Company has been providing  complete  hardware and software  solutions using
Key-From-Image  (KFI) and  Key-From-Paper  (KFP) data entry since 1976. This KFI
and KFP  solution  remains  important  today,  using the latest open network and
platform  designs with Windows,  UNIX,  Novell,  TCP/IP,  NT, and other industry
standard  components.  By combining  the  high-speed  scanning  systems with the
flexibility  of KFI and KFP,  customers  are able to lower  their  overall  data
capture and document processing costs while improving the level of data accuracy
and availability.

Line of Business Domain Knowledge
The  Company   provides   solutions   that  are  proven,   cost-effective,   and
production-ready.  The  Company  has  the  domain  knowledge  to  provide  total
solutions in the following industries:  government,  insurance,  transportation,
financial  and order  entry.  That domain  knowledge  is utilized in the product
suite of applications; TAXexpress(TM),  ORDERexpress(TM),  PROOFexpress(TM), and
ImageEMC++.

Professional Services
In order to provide a total solution to the customer, the Company has provided a
consultative  approach to integrate solutions with proven Professional  Services
core competencies in the following areas:

 Paper Handling             Application Expertise         Project Management
 Installation               Training                      Archival / Retrieval
 Custom Engineering         Development Tools             Forms Design
 Open Systems               Neural Technology             System Integration
 Microfilming               OCR Technology                Industry Standards
 Imaging                    Networking

The Company has provided  software  solutions to its customers  since 1968.  The
Company's  scanners and assorted  network system  products  provide the hardware
platforms for delivering  advanced  high-volume forms processing,  imaging,  and
document  management  system  solutions,  especially in  government,  insurance,
transportation,  financial, and order entry. These software solutions enable the
Company  to  provide  full  production-ready  application  systems  that  can be
tailored to the customer's specific needs.

These targeted solutions are provided through  professional  services offered by
the Company. The Company also provides  individual,  custom software services as
requested  by the  customer.  In this way,  the Company  can either  provide the
entire  package of software  support or simply  provide those  services that the
customer desires.



                                       7
<PAGE>


Value Added Engineering Services and Solutions
The  Company has been  supplying  engineering  services  and  solutions  to meet
customer needs since  introducing its first fully  integrated  solution in 1976.
The solutions include  scanning,  recognition,  Key-From-Image,  data entry, and
communications.  During  1993,  the Company was  selected to develop a prototype
system to process medical claims for a healthcare  agency in Japan.  This system
was designed with 36 stacker pockets for sorting forms;  expanded paper handling
capabilities for  light-weight,  flimsy forms;  high resolution image cameras to
permit  recognition  of complex  Japanese kanji  characters;  and software forms
recognition for up to 20,000 different document formats.

The Company has been involved in special recognition techniques to process order
forms that contain stamps.  These stamps are used as an entry into a sweepstakes
contest or to select  ordered items for a record or book club. The stamps are of
a multitude  of colors and are  successfully  processed  through  the  Company's
special recognition features.  In addition to stamp processing,  the Company has
been engaged in recognition analysis for educational test scoring.  This process
is  accomplished  in full  duplex  mode at a  transport  speed of 50 inches  per
second.  Test scoring and balloting  includes  Optical Mark Read (OMR) and image
presentment  of text pages to  knowledge  workers for value added  analysis  and
grading.


ACCESS SERVICES DIVISION

The  Company has been  offering  service  and  maintenance  support to its broad
customer  base since 1968.  This  support is  available  with  either  leased or
purchased systems in both domestic and international markets.

In June of 1998,  the Company  acquired  the  hardware  maintenance  division of
Access  Corporation  of  Cincinnati,  Ohio.  This  business  was  combined  with
Scan-Optics'  existing hardware  maintenance division to form Access Services, a
separate  division,  dedicated to serving the Scan-Optics  customer base and the
third party maintenance marketplace.

Service is provided through a network of over 140 service centers worldwide. The
Company  provides  on-site service with response times of 2 to 24 hours based on
the service plan selected by the customer.  The Company focuses on comprehensive
diagnostic  routines,  modular designs,  preventive  maintenance  procedures and
customer  surveys  to  provide  its users high  system  availability  to perform
mission critical applications.

The  Company's   customers   include   government,   healthcare   organizations,
transportation,   subscription  and  catalog  fulfillment  companies,  financial
institutions and manufacturers in the U.S.,  Canada,  Latin America,  Europe and
Asia.   The  Company   maintains   high   standards  of  teamwork  and  customer
satisfaction.





                                       8

<PAGE>



CONTRACT MANUFACTURING SERVICES

Through  this  component of the  Manufacturing  Services  Division,  the Company
provides  electro-mechanical  assembly and test services  under  contracts  with
customers who develop and sell a variety of equipment.

Beginning with the customer's  plans,  Scan-Optics  can manage each project from
concept to completion. The capabilities provided include:

Project Management
Engineering and Prototyping
Procurement and Materials Management
Precision Machining, Sheet Metal Fabrication and Welding
Networks/System Integration
Systems Testing
Just-in-Time/Kanban Delivery Systems
Professional Services and Training
Worldwide Field Service - through Access Services
Strong Supplier Partnerships with:
         Agency Standards Certification (FCC, UL, LE, CSA, ISO 9001)
         Commercial Painting and Metal Finishing
         Printed Circuit Board Assemblies and Testing
         Wire Harness and Cable Assembly and Testing
         Specialty Packaging
         Worldwide Shipping


SIGNIFICANT CUSTOMERS

In 2000 and 1998,  the Company  derived 13% and 12%  respectively,  of its total
revenue  from  one  customer,  Toyo  Officemation,  Inc.,  one of the  Company's
distributors  in Japan.  In 1999,  the Company  derived 11% of its total revenue
from one customer,  the Kentucky  Revenue  Cabinet,  a state  government  taxing
authority.


CHANNELS OF DISTRIBUTION

The  Company  sells  directly  to  end-users  and  distributors.  It also  pools
resources  with  selected  system   integration   firms  and  specialized  niche
suppliers.  The cooperative effort with system integrators and other vendors has
introduced  the  Scan-Optics   logo  to  new  markets  both   domestically   and
internationally.


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<PAGE>



BACKLOG

The backlog for the Company's  products and services as of December 31, 2000 was
approximately   $15.3 million.  As  of  December  31,  1999,   the  backlog  was
approximately  $18.4 million.  The backlog  consists of equipment,  software and
services to be sold and  noncancelable  rentals and  maintenance due on existing
rental and  maintenance  contracts  over the next  year.  The  Company  normally
delivers a system within 30 to 180 days after receiving an order, depending upon
the degree of software customization required.


MANUFACTURING

Manufacture of the Company's  products  requires the  fabrication of sheet metal
and mechanical  parts,  the  subassembly of electronic and mechanical  parts and
components,   and   operational  and  quality  control  testing  of  components,
assemblies and completed systems. The Company's products consist of standard and
Company-specified  mechanical and  electronic  parts,  sub-assemblies  and major
components,  including  microcomputers.  A  majority  of  parts  are  purchased,
including many complex electronic and mechanical subassemblies. The Company also
purchases major standard  components,  including low speed scanners,  jukeboxes,
PCs,  printers and servers.  An important aspect of the Company's  manufacturing
activities  is its  quality  control  program,  which  uses  computer-controlled
testing equipment.

The Company has not  experienced  significant  shortages  of any  components  or
subassemblies. Alternate sources for such components and subassemblies have been
developed.  Certain  sole source items have been  evaluated  and the Company has
determined  that a minor  engineering  effort  would be  required  to  qualify a
replacement.  During  2000,  the Company  experienced  delays in the shipment of
components and subassemblies arising from the Company's lack of liquidity.


COMPETITION

The Company's  Solutions and Products  Division  competes with service providers
who  integrate  systems  with  products  from  multiple  vendors.   The  Company
differentiates  its  solutions  by  offering  a  total  system,  including  post
installation support of hardware and software services along with image scanning
and  document  handling  transports.  The Company  focuses on industry  specific
"application"  areas with solutions  utilizing image and data entry/data capture
systems provided by the Company.

A large portion of the revenue generated by the Access Services Division is from
post installation hardware and software services on integrated systems installed
by the Company's Solutions and Products Division.  Due to the proprietary nature
of these  integrated  systems,  this division faces little  competition for this
business.   The   remaining   revenue  is  generated  by  the  field  repair  of
electro-mechanical  devices  manufactured by Original  Equipment  Manufacturers,
primarily  of  scanner  products,  that do not have their own field  staff.  The
division competes


                                       10
<PAGE>

with other  third  party  maintenance  providers  for this  revenue by using its
reputation  for  quality and its 31 years of  experience  in  providing  scanner
repair.

Contract  Manufacturing,  a component of the  Manufacturing  Services  Division,
provides  electro-mechanical  assembly and test services  under  contracts  with
customers who develop and sell a variety of equipment.  The primary  competition
for this business is the customers  themselves who can decide to manufacture the
products   instead  of  outsourcing   them.   Competition  from  other  contract
manufacturers is minimal due to the Company's expertise in the electo-mechanical
field as well as the flexibility to handle various order requirements.


ISO 9001 CERTIFICATION

On November  12,  1999,  the Company  received  ISO 9001  certification  for its
product development and manufacturing  divisions. The scope of the certification
is  for  the  design  and   production   of  scanning   equipment  and  contract
manufacturing of electronic equipment.

In 2000,  the  Company  took the first step in expanded  its quality  program by
bringing the service and installation  areas into  compliance.  The Company also
performed  internal  audits to test for  compliance  in the  sales,  design  and
manufacturing  areas. The registering body performed two surveillance  audits on
the Company's  product  development and manufacturing  divisions,  both of which
were successful.


PATENTS

The Company  currently  has nine  United  States  patents in force which  expire
between  2003 and  2018.  The  patents  are on  mechanical  systems,  electronic
circuits,  electronic systems and software algorithms, which are used throughout
the product lines. The Company values the investments made in new technology and
makes all efforts to protect its intellectual  property.  The Company expects to
continue  to apply for  patents on its new  technological  developments  when it
believes they are  significant.  In November 1997, the Company licensed a patent
to Imaging Business Machines,  LLC. for their use in an image transport designed
for processing  airline tickets.  In 1999, this same patent was licensed to Nale
Corporation for use on its paper handling  transports.  In 2000, the engineering
organization  filed  for a  patent  for  gray  scale  OMR  used in test  scoring
applications  and a  patent  for a  double  document  detection  system  for our
scanners.


EMPLOYEES

As of December  31, 2000 the Company  employed  247  persons,  including 21 with
administrative and support  responsibilities,  23 in marketing and sales, 139 in
software  and service  activities,  23 in  engineering  and 41 in  manufacturing
capacities. The Company considers its employee relations to be good. The Company
has not experienced any work stoppages.


                                       11
<PAGE>



FUNDED DEVELOPMENT AGREEMENTS

During 1998, the Company completed a $200,000 custom development  project with a
specific customer. The project involved adding fluorescent bar code printing and
reading to the Series 9000  product  and adding  additional  stacker  modules to
accommodate the document sorting  requirement.  The Company recorded all revenue
related to this  development  agreement in 1998.  These revenues  offset related
costs incurred to develop the modifications  and enhancements.  The ownership of
the technologies created as a result of this development  agreement remains with
the Company. No royalties or other considerations are required as a part of this
agreement.

During 1999,  the Company  entered into four custom  development  agreements for
specific   customers.   A  $125,000   agreement   involved  the  development  of
localization  software for screen displays in Japanese. A $115,000 agreement was
for recognition  enhancements to a current product. A $75,000 agreement involved
enhancements for the reading of Japanese stock certificates. A $58,000 agreement
involved  software  developments  for the  processing  of mortgage  payments and
taxes. The Company recorded all revenue related to these development  agreements
in 1999. These revenues offset the related costs incurred for this  development.
The ownership of these  technologies  remains with the Company.  No royalties or
other considerations are required as part of these agreements.

During  2000,  the  Company  completed  a  number  of small  custom  development
contracts for specific customers resulting in approximately  $200,000 of revenue
recognized  during the year. The Company  recorded all revenue  related to these
development agreements in 2000. These revenues offset the related costs incurred
for this  development.  The  ownership  of these  technologies  remains with the
Company.  No  royalties  or other  considerations  are required as part of these
agreements.

EFFECTS OF ENVIRONMENTAL LAWS

The effect of  federal  and state  environmental  regulations  on the  Company's
operations is insignificant.











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<PAGE>



BUSINESS SEGMENTS

The Company views its business in three distinct revenue  categories:  solutions
and products, Access Services and contract manufacturing services.  Revenues are
used by management as a guide to determine the  effectiveness  of the individual
segment.  The  Company  manages its  operating  expenses  through a  traditional
functional  perspective and accordingly does not report operating  expenses on a
segment basis.

<TABLE>
<CAPTION>
                                                        Year Ended December 31
(thousands)                                   2000              1999               1998
-----------------------------------------------------------------------------------------
<S>                                        <C>                <C>                <C>
Revenues
  Solutions and products                   $ 21,272           $ 34,921           $ 40,174
  Access services                            14,692             16,003             13,222
  Contract manufacturing services             2,338              1,068                575
                                          -----------------------------------------------
    Total revenues                           38,302             51,992             53,971

Cost of solutions and products               21,717             27,656             24,438
Service expenses                             12,376             12,817              9,590
                                          -----------------------------------------------

    Gross profit margin                       4,209             11,519             19,943

  Operating expenses, net                    21,918             19,934             16,709
                                          -----------------------------------------------
Income (loss) before income taxes         $ (17,709)          $ (8,415)          $  3,234
                                          ===============================================

Total assets                               $ 34,436           $ 55,186           $ 52,992

Total expenditures for additions to
long-lived assets                          $    109           $    596           $    560
</TABLE>

Certain 1999 and 1998 amounts have been  reclassified  to conform to the current
year presentation.

Note: In 2000 and 1998,  the Company  derived 13% and 12%  respectively,  of its
total revenue from one customer,  Toyo Officemation,  Inc., one of the Company's
distributors  in Japan.  In 1999,  the Company  derived 11% of its total revenue
from one customer,  the Kentucky  Revenue  Cabinet,  a state  government  taxing
authority.

Sales of product to customers in the international market represent an important
source of the Company's  revenues.  The Company has  international  distributors
located in 46 countries  and covering  six  continents.  Changes in the economic
climates  of  foreign  markets  could  have  an  unfavorable  impact  on  future
international sales.




                                       13
<PAGE>



Export sales by geographic  area (based on the location of the customer) were as
follows:

(thousands)                  2000                1999                 1998
-----------------------------------------------------------------------------

Latin America        $    152     2%      $    77      2%     $     88     1%
Europe                  1,667    22%        1,982     41%          328     3%
Pacific Rim             5,881    76%        2,743     57%        9,649    96%
                     --------------------------------------------------------
                     $  7,700             $ 4,802             $ 10,065
                     ========================================================

Export sales  represented 43%, 20%, and 31% of product sales for the three years
ended December 31, 2000, 1999, and 1998, respectively.


ITEM 2 - PROPERTIES

The Company's  world  headquarters  and  manufacturing  facility is located in a
84,000 square foot, one-story building in Manchester,  Connecticut, leased for a
term  expiring in December  2006.  The Company  also leases 1,238 square feet of
office  space,  under a lease  expiring  in July  2002,  in  Dallas,  Texas  for
professional services and sales.

Scan-Optics,  Ltd., a wholly owned subsidiary in the United Kingdom, also leases
office space for sales, service, and equipment demonstration.


ITEM 3 - LEGAL PROCEEDINGS

There is one lawsuit currently  pending against the Company.  This lawsuit is in
reaction to a lawsuit filed by the Company  against the plaintiff.  Although the
ultimate  outcome is  uncertain,  based on currently  known  facts,  the Company
believes that it has strong defenses  against this lawsuit and the resolution of
this matter will not have a material  adverse effect on the Company's  financial
position or annual operating results.


ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company did not submit any  matters  during the fourth  quarter of 2000 to a
vote of the stockholders.













                                       14
<PAGE>


EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT

Officers of the Company are set forth in the schedule below.

                                                                       Officer
Name                      Age    Principal Occupation:                  Since
--------------------------------------------------------------------------------

James C. Mavel            55     Chairman, Chief Executive Officer,
                                 President and Director                 1996

Joseph P. Crouch          38     Vice President -
                                 Manufacturing Services Division        1999

Marianna C. Emanuelson    39     Vice President -
                                 Human Resources                        1997

Richard C. Goyette        49     Vice President -
                                 Sales and Marketing                    1996

Richard D. Harris         40     Corporate Secretary                    2001

Joel K. Howser            53     Vice President -
                                 Software Development                   1998

Clarence W. Rife          61     Vice President -
                                 Access Services Division and
                                 Hardware Engineering                   1975

Michael J. Villano        41     Chief Financial Officer, Vice
                                 President and Treasurer                1992

Alan W. Ware              62     Vice President -
                                 Project and System Integration         2000




Mr. Mavel joined the Company in January  1996 as President  and Chief  Operating
Officer.  In June 1996, Mr. Mavel became a Director of the Company.  On December
31, 1996, Mr. Mavel was promoted to Chief  Executive  Officer.  In May 1997, Mr.
Mavel was  elected  Chairman  of the Board of  Directors.  Prior to joining  the
Company,  from 1992  through  1995,  Mr.  Mavel was Vice  President  and General
Manager of the Imaging  Systems  Division of Unisys.  From 1991 to 1992,  he was
Group Vice President of the Financial  Information  Systems Division of National
Data Corporation.




                                       15
<PAGE>



Mr.  Crouch  joined the Company in March 1999 and was elected to the position of
Vice President -  Manufacturing  Services  Division in November  1999.  Prior to
joining the Company,  Mr. Crouch was Director of  Manufacturing  Operations  for
CalComp's Input Technologies Division. Mr. Crouch had over ten years of contract
manufacturing experience before joining the Company.

Ms.  Emanuelson  joined  the  Company  in August  1994,  and was  elected to the
position of Vice  President  in 1997.  She is currently  Vice  President - Human
Resources.

Mr.  Goyette  joined the  Company in March  1996 as Vice  President  - Sales and
Marketing. Prior to joining the Company, from 1993 through 1995, Mr. Goyette was
Vice President of the Imaging Systems Division of Unisys.  From 1992 to 1993, he
was Vice President of the Software  Products Group of Unisys.  From 1990 to 1992
he was Vice President of Corporate  Information  Productivity Systems of Unisys.
He is currently Vice President - Solutions and Products Division.

Mr. Harris has been a partner in the law firm of Day, Berry and Howard LLP since
1998. He was elected to the position of Corporate Secretary in January 2001.

Mr. Howser joined the Company in February 1997 as Vice President - Marketing. In
December of 1997,  Mr. Howser  assumed the  responsibility  of Vice  President -
Product  Development.  Prior to joining the Company,  from 1989 through 1996, he
was director of  development  for Unisys in its image  program.  Mr.  Howser had
twenty years of experience in transaction  processing and OCR/image  development
prior to joining Unisys.

Mr.  Rife has been  employed  by the  Company  since 1969 and was elected to the
position of Vice  President  in 1975.  He is currently  Vice  President - Access
Services Division.

Mr.  Villano  joined  the  Company  in 1986  and in  1988  was  named  Assistant
Controller.  In 1989 he was promoted to the position of Controller,  in February
1992 was named Vice  President and  Controller and in March 1994 was named Chief
Financial Officer and Vice President. Mr. Villano was appointed Treasurer in May
1997.

Mr.  Ware  joined the  Company in October  2000 as Vice  President - Project and
System Integration.  Prior to joining the Company he was Chief Executive Officer
and Chairman of American OBGYN,  Inc.  (formally  Spectrascan  Imaging Services,
Inc.)  from  1984 to 2000.  He was Vice  President  of Sales and  Marketing  for
Scan-Optics  from 1974 to 1984 and Director of Engineering and Customer  Service
at Recognition Equipment from 1968 to 1974. Mr. Ware is a member of the Board of
Directors of Quality Care Solutions Inc.

The  executive  officers  are  elected  for a one  year  term  effective  at the
conclusion of the Annual Meeting of Stockholders  each year. There are no family
relationships between any of the listed officers.



                                       16
<PAGE>


                                     PART II


ITEM 5 - MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON
         EQUITY AND RELATED STOCKHOLDER MATTERS


COMMON STOCK MARKET PRICES AND DIVIDENDS

The following is a two year history of Common Stock prices for each quarter. The
table sets forth the high and low closing  quotations  per share for the periods
indicated  of  the  Common  Stock  in the  over-the-counter  market  based  upon
information  provided by the National  Association of Securities  Dealers,  Inc.
Effective November 10, 2000 the Company was notified by The NASDAQ Stock Market,
Inc. that its common stock will begin  listing on the Over the Counter  Bulletin
Board.  This action was taken  because of the  inability  to maintain the $1 per
share bid price  requirement  for continued  listing on the NASDAQ Stock Market.
The  closing  quotations  represent  prices  between  dealers and do not include
retail  markups,   markdowns  or  commissions  and  may  not  represent   actual
transactions. There were 1,051 stockholders of record at December 31, 2000.

<TABLE>
<CAPTION>
Quarter Ended          March 31                 June 30                   September 30            December 31
                  High         Low          High          Low          High         Low         High        Low
---------------------------------------------------------------------------------------------------------------
<S>              <C>        <C>          <C>           <C>          <C>           <C>        <C>         <C>
2000             4 3/4        1 9/16       2             6/16         1 3/16         1/2        13/16       1/8
1999             5 1/2        3 1/2        4 3/8        3 1/8         4 7/16       2 3/4        2 7/8     1 1/8
</TABLE>



The  Company  has not  paid  dividends  on its  Common  Stock  and the  Board of
Directors  of the  Company  has  no  intention  of  declaring  dividends  in the
foreseeable  future. The declaration and payment of dividends in the future will
be determined by the Board of Directors in light of  conditions  then  existing,
including the Company's earnings,  financial condition, capital requirements and
other factors.











                                       17
<PAGE>

ITEM 6 - SELECTED FINANCIAL DATA


SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS

SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
(thousands, except share data)               2000               1999                1998            1997                1996
---------------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                <C>                <C>               <C>                <C>
Total Revenues                          $    38,302        $    51,992        $    53,971       $    56,608        $    46,034
                                     ===========================================================================================

Income (loss) before income taxes           (17,709)            (8,415)             3,234             5,691              3,265

Income taxes (benefit)                           61               (240)             1,105               (99)                (9)

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

Net Income (Loss)                       $   (17,770)       $    (8,175)       $     2,129       $     5,790        $     3,274
                                     ===========================================================================================

Basic earnings (loss) per share         $     (2.53)       $     (1.17)       $      0.31       $      0.87        $      0.50


Basic weighted-average shares             7,025,064          6,979,651          6,921,331         6,632,248          6,530,244

Diluted earnings (loss) per share       $     (2.53)       $     (1.17)       $      0.30       $      0.82        $      0.49

Diluted weighted-average shares           7,025,064          6,979,651          7,102,658         7,070,013          6,715,942


SELECTED BALANCE SHEET DATA

Total assets                            $    34,436        $    55,186        $    52,992       $    38,707        $    31,121

Working capital (deficit)               $    (9,833)       $     4,727        $    15,107       $    24,643        $    17,318

Total stockholders' equity              $     4,307        $    22,081        $    30,246       $    27,733        $    21,207
</TABLE>


The Company has not paid any dividends  for the five year period ended  December
31, 2000.

The  above  financial  data  should  be read in  conjunction  with  the  related
consolidated financial statements and notes thereto.

The earnings per share  amounts  prior to 1997 have been restated as required to
comply with Statement of Financial  Accounting  Standards No. 128,  Earnings Per
Share.  For further  discussion of earnings per share, see Notes to Consolidated
Financial Statements.


                                       18
<PAGE>


ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Outlook
The forward-looking  statements  contained in this Outlook and elsewhere in this
document are based on current  expectations,  Scan-Optics,  Inc. (the "Company")
and its future  operations  are  subject to a number of risks,  including  those
discussed  below. The following list is not intended to be an exhaustive list of
all the risks to which the Company's business is subject,  but only to highlight
certain  substantial  risks  faced by the  Company.  The  Company  will  need to
negotiate an extension from its existing lender or locate alternative sources of
financing in order to continue to operate its  business as  currently  conducted
and implement its business plan. The Company's  ability to ship its products and
fulfill  contracts on a timely basis may be limited by a lack of liquidity.  The
Company's  business could be adversely affected by downturns in the domestic and
international  economy.  The Company's  international  sales and  operations are
subject to various  international  business risks. The Company's revenues depend
in part on contracts with various state or federal  governmental  agencies,  and
could be  adversely  affected by patterns in  government  spending.  The Company
faces  competition  from many  sources,  and its products  may be replaced  with
products relying on alternative  technologies.  The Company's  business could be
adversely affected by technological changes. The foregoing factors should not be
construed as exhaustive.

The Company  experienced  a net loss of $17.8  million in 2000,  $6.3 million of
which  related  to one time  charges  associated  with  various  allowances  for
accounts receivable,  inventories and an investment in a contract  manufacturing
customer.  The operating loss, without the one time charges,  was $11.5 million.
This loss was primarily  related to professional  services  projects  started in
1999 that resulted in revenue delays and expense overruns in both 1999 and 2000.
The Company is  substantially  complete  with these  projects as of December 31,
2000.  The Company  also  suffered  from a shortage of  liquidity,  which caused
various  scanner  systems  and parts  shipments  to be delayed,  which  impacted
revenue in the second, third and fourth quarters of 2000.

The Company has three major  initiatives  currently  underway to improve revenue
growth and  profitability.  They are to emphasize  the  "Business of  Solutions"
focus in targeted  markets,  to decrease  market risk  through  expansion in the
international  marketplace,  and to capitalize on existing core  competencies of
the Company.  A fourth  initiative that is currently on hold is to add long term
value through the  acquisition  of key strategic  products or  enterprises.  The
inability  of the  Company  to carry out these  initiatives  may have a material
adverse effect on revenue growth and earnings.

The  first  initiative  is to  provide  cost  effective  solutions  through  the
Company's  development of target market data capture applications  combined with
its high speed  transports  and  archival  systems.  The Company has refined its
target market  approach and has chosen to focus  primarily on the government and
insurance markets, while continuing to address the transportation, financial and
order entry markets.  The Company expects to continue to


                                       19
<PAGE>

emphasize its "Business of Solutions"  focus on these  targeted  markets for the
foreseeable  future.  As other  market  opportunities  emerge,  the Company will
evaluate the  potential of using its products and services to provide  solutions
in these new markets. The Company's revenue in the solutions initiative declined
by $6.5 million or 27% from 1999. The health  insurance market increased by 174%
while the other markets showed a decline of 50%.

The second initiative is further  expansion into the international  marketplace.
The Company has  successfully  supplied  product to the Japanese  market and has
experienced strong sales activity in the past through  relationships with highly
qualified  and  productive  distributors.  The Company will continue to focus on
developing strong  relationships in Europe,  Latin America and other Pacific Rim
countries.  During  2000,  the  Company  made  significant  progress  with  this
initiative.  The Company  experienced a revenue increase of $3.1 million or 114%
in Japan.  The economic  environment  in Latin America has been an impediment to
growth in these markets.  The Company  continues to strengthen its relationships
in Europe as a target for future growth, although in 2000 there was a decline of
16% from 1999 levels.

The third initiative relates to leveraging the Company's core competencies in an
effort to offset fixed  expense and add  revenues  and profits.  The Company has
demonstrated  that Access  Services and  Contract  Manufacturing  Services  have
potential to sell their individual expertise,  experience and cost effectiveness
to other entities.  During 2000, Access Services signed agreements with five new
hardware  manufacturers  for third party  maintenance,  most notably with Canon.
These agreements cover  approximately 30 end-user  customers.  In 2000, Contract
Manufacturing  was  successful  in obtaining  four new  contracts,  of which $.6
million was recorded as revenue during the year.

The Company has put on hold its initiative of long term growth through accretive
acquisitions  of key strategic  products or enterprises.  No  acquisitions  were
considered  during  2000  due to  management's  focus on the  operations  of the
business and the liquidity  shortfall the Company  faced.  During the year,  the
Company entered into a joint marketing agreements with Neurascript, an automated
data capture text recognition  solution  provider,  Mitek, an offline neural OCR
software  engine,  Maximal,  a computer output to laser disk software  provider,
Actionpoint, a system integration software toolkit and KPMG, LLC, a professional
service  organization.  During 1999, the Company completed an acquisition of the
scanner and maintenance division of Photomatrix Imaging Corporation,  a supplier
of high  performance  imaging  products.  The  Company  also  signed a licensing
agreement  with  Bluebird  Systems for a suite of document  management  software
products that encompass object management and workflow in 1999. During 1998, the
Company completed two acquisitions,  Southern Computer Systems (SCS), a software
and  solutions  provider  and  the  hardware   maintenance  division  of  Access
Corporation.


RESULTS OF OPERATIONS - 2000 VS. 1999

Total revenues decreased $13.7 million or 26% from 1999 to 2000.

Product sales decreased $5.7 million or 24% from the prior year.  North American
sales  decreased  $8.6  million  or 45% due  mainly  to the  focus of the  sales
organization on improving customer  satisfaction and helping manage deliverables
related to the professional services


                                       20
<PAGE>

implementations  underway  from the third and fourth  quarters of 1999.  Product
sales were also  impacted  in the last  three  quarters  of 2000 as orders  were
received but  shipments  were delayed due to the lack of cash  liquidity.  Total
international sales increased $2.9 million or 60% from 1999. International sales
in the Pacific Rim  increased  114% or $3.1 million due to a  substantial  spare
parts sale in support of the  systems  installed  at the  National  Ministry  of
Health as well as eight new system sales for prefecture based claims processing.
Sales to Europe  decreased $.3 million or 16% and Latin  American sales remained
consistent  with the prior year mainly due to the continued  decline in economic
conditions in the Latin American countries.

Service revenues decreased $7.7 million from 1999 to 2000. Hardware  maintenance
and support  revenue  decreased  $1.3  million or 8% due mainly to year 2000 non
compliant  systems removed from maintenance and either replaced with new systems
that carried warranty periods and lower maintenance  revenues or not replaced at
all.  Professional  service  revenue  decreased  $6.4  million or 55% due to the
Company's focus on the completion of projects from the third and fourth quarters
of 1999 as well as a cautious  approach to accepting new business until the past
issues  relating  to  professional  services  deliverables  were  addressed  and
mitigated.

Engineering  revenues  decreased $.3 million from 1999 to 2000 due to a decrease
in customer funded  development  contracts from 1999 levels.  (See Note I of the
Notes to Consolidated Financial Statements.)

Cost of product sales  decreased $1.4 million from 1999 to 2000. Cost of product
sales as a  percentage  of product  sales  increased  from 67% in 1999 to 81% in
2000.  The  percentage  increase is due mainly to a $2.3  million  reduction  in
software product revenue from 1999 to 2000 which carries a significantly  higher
gross margin than hardware sales.

Service  expenses  decreased  by $5 million  in 2000.  Access  service  expenses
decreased  $.4  million  or 3% due to a  reduction  in  revenues  and  continued
management  of the  field  workforce  in  relation  to  the  installed  base  of
customers.  Professional  service  expenses  decreased $4.6 million from 1999 to
2000 due mainly to the Company completing the majority of the projects that were
in process from the end of 1999 and a reduction in the number and total value of
new projects that were initiated during the year.

Sales  and  marketing  expenses  decreased  by $2.1  million  in  2000  due to a
reduction in commissions  expense  related  directly to the reduction in revenue
and  reductions in other expenses as part of the increased  management  focus on
expenses.

Research and development  expenses  decreased $2 million from 1999 due mostly to
the  reduction  in  headcount,  outside  contractors  and third party  purchased
services.  The Company is continuing  to refine its focus on software  products,
solutions and specific development activities.  As a result, certain development
skills were no longer required, allowing for the reductions.

General and  administrative  expenses increased $4.9 million in 2000 compared to
the  prior  year.  The  increase  is due to the  accounts  receivable  allowance
recorded for various  accounts that were determined to be  uncollectable  during
the fourth quarter of 2000.


                                       21
<PAGE>


Interest  expense  increased  $1.1 million due to the change in interest rate at
the end of the first quarter of 2000 from prime to prime plus five percent.

RESULTS OF OPERATIONS - 1999 VS. 1998

Total revenues decreased $2 million or 4% from 1998 to 1999.

Product sales  decreased  $9.2 million or 28% from the prior year. The Company's
core business  sales  decreased  $3.5 million or 13% from 1998 to 1999. The core
business includes all domestic and  international  sales except those for health
claims  processing to the Japanese  government.  The Japanese Ministry of Health
sales  accounted for $5.7 million of product sales in 1998.  There were no sales
to this customer in 1999. North American sales decreased $3.9 million or 17% due
mainly  to Y2K  concerns  in the  second  half of 1999  that  deferred  purchase
decisions by some potential customers as well as the internal focus of the sales
organization on improving customer  satisfaction and helping manage deliverables
related to the professional services  implementations  underway in the third and
fourth quarters of 1999. Total international sales decreased $5.3 million or 52%
from  1998.  International  sales in the  Pacific  Rim that  relate  to the core
business  declined  31% or $1.2  million  due to the  continued  slowdown in the
Japanese  economy  and sales to Europe  increased  $1.6  million or 504%.  Latin
American  sales  remained  consistent  with the  prior  year  mainly  due to the
continued decline in economic conditions in the Latin American countries.

Service revenues increased $7.1 million from 1998 to 1999. Hardware  maintenance
and  support  revenue  increased  $2.8  million  or 21%  due to  the  June  1999
acquisition of the assets of PHRX as well as continued growth of the third party
maintenance business. Professional service revenue increased $4.3 million or 58%
due to an increase in the focus on the  "Business of  Solutions",  the marketing
campaign to provide greater customer value in the target markets, as well as the
acquisition  of SCS,  in June of 1998,  which had a full year of revenue in 1999
compared to a half year in 1998.

Engineering  revenues increased $.3 million from 1998 to 1999 due to an increase
in customer funded  development  contracts from 1998 levels.  (See Note I of the
Notes to Consolidated Financial Statements.)

Cost of product sales  decreased $3.3 million or 17% from 1998 to 1999.  Cost of
product sales as a percentage of product sales  increased 8% from 59% in 1998 to
67%  in  1999.  The  percentage  increase  is  due  to  decreased  manufacturing
production  volumes,  lower margins on commodity items sold as part of the total
customer solution and increased contract  manufacturing  revenue which carries a
lower margin.

Service  expenses  increased by $9.7 million in 1999.  Customer service expenses
increased  $3.2 million or 34% due to the  acquisition  of the assets of PHRX in
June of 1999, a full year of expenses  associated  with the  acquisition  of the
hardware  maintenance  division of Access Corporation compared to a half year of
expenses  in 1998  and the  growth  of the  third  party  maintenance  business.
Professional  service  expenses  increased $6.5 million from 1998 to 1999 due in
part to the  increase  in revenue  as well as a full year of expense  associated
with the purchase of SCS which occurred in June of 1998.  However,  the expenses
associated with professional  services  integration  projects were significantly
higher than anticipated in the


                                       22
<PAGE>

second half of 1999  because of project  management  problems and the expense of
hiring  outside  contractors  to assist in  project  completions.  This has been
addressed with a management  change and a  comprehensive  plan to improve system
design, project management and customer implementations.

Sales  and  marketing  expenses  increased  by $1  million  in  1999  due to the
acquisition  of the assets of PHRX and a full year of expenses  associated  with
the  acquisition  of SCS  compared  to a half  year  of  expenses  in  1998  and
commission expenses.

Research and development  expenses increased $.1 million from 1998 due mostly to
the  acquisition of PHRX assets offset by a reduction in headcount in the fourth
quarter of 1999.  The  Company  is  continuing  to refine its focus on  software
products and solutions,  and as a result,  certain development skills related to
hardware platforms were no longer required.

General and administrative expenses increased $1 million in 1999 compared to the
prior year. The increase is mainly due to the  amortization  of goodwill for the
SCS  acquisition,  expenses  related  to the  non-compete  agreements  with  the
principals  of SCS,  outside  services,  expenses  associated  with tax planning
activities, and legal expenses related to acquisition activities.

Interest expense increased $.9 million due to the funding  requirements  related
to the  acquisition  of PHRX assets  completed  during the second  quarter,  the
purchase of the source code license from Bluebird  Systems and the loss reported
by the Company which required additional borrowings under the credit agreement.

Income taxes  decreased  $1.3 million from 1998.  The  Company's  effective  tax
benefit  rate for 1999 was 3% as the  current  income tax benefit of $.9 million
was limited to amounts  that are  recoverable  for taxes paid in prior years for
which a tax  carryback  is  available,  offset by a valuation  allowance  of $.7
million for net deferred tax assets.



LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents remained consistent from 1999 to 2000.

At December  31,  2000,  the Company had $18 million in  outstanding  borrowings
against its $18.5 million available borrowings.  The average borrowing level for
2000 was $18.1  million  compared  to $15.5  million for 1999.  The  increase in
borrowing level is directly related to the loss the Company reported in 2000.

The Company is operating  under a credit  agreement with Patriarch  Partners LLC
(Agreement) which Fleet National Bank sold to Patriarch Partners, LLC on January
4, 2001. The Agreement contains covenants which, among other things, require the
maintenance of specified  working  capital,  debt to equity  ratios,  net income
levels,  tangible net worth levels and backlog levels.  The Company entered into
an amendment and waiver  agreement with Patriarch  Partners,  LLC on January 31,
2001 that waived defaults on the Company's revolving and term loans through July
1, 2001. The Company is in the process of negotiating  with Patriarch  Partners,
LLC a total


                                       23
<PAGE>

debt  restructuring  to meet its  short-term  and long-term  capital  needs.  If
negotiations on the revision of the Agreement with Patriarch  Partners,  LLC are
not  complete by the end of the second  quarter,  the Company  will  continue to
negotiate  with  other  bank and  finance  companies,  as well as  review  other
business  and  financing  options.  There can be no assurance  that  alternative
sources of financing will be available on acceptable terms.  These matters raise
substantial doubt about the Company's ability to continue as a going concern.

Operating  activities  used $.7 million of cash in 2000 compared to $3.5 million
in 1999.  The  non-cash  expenses  in 2000 were $11.2  million  compared to $5.3
million in 1999. The non-cash items relate to depreciation of fixed assets which
is discussed in net plant and equipment below,  amortization of customer service
spare  parts  inventory,  amortization  of  goodwill,  provisions  for losses on
accounts receivable,  provisions for inventory  obsolescence and deferred taxes.
Other components of operating activities are discussed below.

Net accounts  receivable  and unbilled  receivables  decreased  $14 million from
December 31, 1999. There are four main factors  associated with the net decrease
in accounts  receivables.  The first factor is the $5.3  million of  receivables
reserved  during  the  fourth  quarter  of 2000,  due to the  status of  various
accounts  with payment  issues.  The second  factor is the  collection  of older
solution  accounts   receivable  whose  collections  were  delayed  due  to  the
professional  service  issues  encountered in the second half of 1999. The third
factor is the  adoption  of a credit hold  policy for all  outstanding  accounts
receivable  greater  than sixty days and the fourth  factor is the  reduction in
total revenue from 1999 levels.

Refundable  and  recoverable  income  taxes  decreased  $1.9  million due to the
collection of amounts due. Substantially all operating loss carrybacks have been
exhausted at December 31, 2000.

Total  inventories  decreased  $1.1  million  from  1999  levels.  Manufacturing
inventories decreased $1.2 million during the year due to a decrease in finished
goods inventory of $.2 million,  a decrease in  work-in-process  inventory of $1
million,  mainly due to the Company's  focused effort to reduce inventory levels
and reduced product sales. The manufacturing  inventory  reduction was offset by
an increase  in  customer  service  inventory  of $.1  million  which was mainly
attributable to the increase in series 8000 inventories.

Net plant and equipment  decreased $.9 million in 2000.  This decrease is mainly
due to recorded  depreciation of $.9 million.  The additions of $.2 million were
offset by the sale of plant and equipment of $.2 million.

Software license decreased by $.6 million due to amortization of the source code
license recorded during the year.

Goodwill  decreased by $1.5 million in 2000 due to  amortization of $1.3 million
and a $.2 million  adjustment to goodwill for  Photomatrix.  The  acquisition of
Photomatrix  assets  occurred in June of 1999. The acquisition was accounted for
as a purchase and the excess cost over the fair value of the net assets acquired
of $1.6 million is being amortized over an average period of twelve and one-half
years.  Southern Computer Systems (SCS), a privately held company, was purchased
in June of 1998. The  transaction was accounted for as a purchase and the excess
cost over the fair value of the net  assets  acquired  of $9.2  million is being
amortized over a



                                       24
<PAGE>

twenty-year  period.  The  acquisition  of the  maintenance  division  of Access
Corporation,  which  also  occurred  in June of  1998,  was  accounted  for as a
purchase and the excess cost over fair value of the net assets  acquired of $3.5
million is being amortized over a five-year period.

Other  assets  decreased  by $.2  million  mainly due to the  conclusion  of the
non-compete  agreements with the principals of SCS which was related to the 1998
acquisition.

Accounts  payable  decreased  $2  million  from  December  31,  1999  due to the
reduction in inventory purchases and the control of expenses.

Salaries and wages  decreased  $.9 million from 1999 mainly due to the reduction
of headcount  and related  benefits  during 2000.  Taxes other than income taxes
decreased by $.7 million due to timing of accruals and related  payments and the
reduction of headcount.





ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Refer  to the  Outlook  section  of  Management's  Discussion  and  Analysis  of
Consolidated Financial Condition and Results of Operations, and to Note A of the
Notes to Consolidated Financial Statements.




















                                       25
<PAGE>







              ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

























                                       26
<PAGE>




                         REPORT OF INDEPENDENT AUDITORS



Stockholders and Board of Directors
Scan-Optics, Inc.

We have audited the  accompanying  consolidated  balance sheets of  Scan-Optics,
Inc.  and  subsidiaries  as of  December  31,  2000 and  1999,  and the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years in the period ended  December 31, 2000.  Our audits also
included the  financial  statement  schedule  listed in the Index at Item 14(a).
These financial  statements and schedule are the responsibility of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements and schedule based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Scan-Optics,  Inc.  and  subsidiaries  at December  31,  2000 and 1999,  and the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended December 31, 2000, in conformity with accounting
principles  generally accepted in the United States.  Also, in our opinion,  the
related financial statement  schedule,  when considered in relation to the basic
financial statements taken as a whole,  presents fairly in all material respects
the information set forth therein.














                                       27
<PAGE>



The  accompanying   financial   statements  have  been  prepared  assuming  that
Scan-Optics,  Inc. will continue as a going concern.  As more fully described in
Notes A and F, the Company has incurred operating losses in 2000 and 1999 and is
operating  under an amendment and waiver  agreement with its lender that expires
in July 2001.  These  conditions  raise  substantial  doubt about the  Company's
ability to continue as a going  concern.  Management's  plans in regard to these
matters are also  described in Notes A and F. The  financial  statements  do not
include  any   adjustments  to  reflect  the  possible  future  effects  on  the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.


                                        /s/ Ernst & Young LLP

Hartford, Connecticut
February 19, 2001
















                                       28
<PAGE>



SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                                    December 31
(thousands, except share data)                                              2000                    1999
---------------------------------------------------------------------------------------------------------
<S>                                                                        <C>                   <C>
Assets
Current Assets:
  Cash and cash equivalents                                                $    36               $    38
  Accounts receivable less allowance of $2,926 in
    2000 and $308 in 1999                                                    8,664                18,713
  Unbilled receivables - contracts in progress less
    allowance of $2,689 in 2000                                              1,064                 5,023
  Refundable income taxes                                                      124                 1,282
  Recoverable income taxes                                                                           740
  Inventories                                                                8,898                10,033
  Deferred costs, net of revenues                                              171                   530
  Prepaid expenses and other                                                   798                   976
                                                                     -----------------------------------
    Total current assets                                                    19,755                37,335


Plant and Equipment:
  Equipment                                                                 13,574                13,735
  Leasehold improvements                                                     5,183                 5,146
  Office furniture and fixtures                                              1,362                 1,312
                                                                     -----------------------------------
                                                                            20,119                20,193
  Less allowances for depreciation and amortization                         18,126                17,337
                                                                     -----------------------------------
                                                                             1,993                 2,856

Software license, net of accumulated amortization
  of $937 in 2000 and  $185 in 1999                                          1,463                 2,040
Goodwill, net of accumulated amortization of $ 3,136 in 2000
  and $1,828 in 1999                                                        10,975                12,523
Other assets                                                                   250                   432
                                                                     -----------------------------------

Total Assets                                                               $34,436               $55,186
                                                                     ===================================
</TABLE>






                                       29
<PAGE>





<TABLE>
<CAPTION>


                                                                                December 31
(thousands, except share data)                                          2000                   1999
------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                     <C>
Liabilities and Stockholders' Equity
Current liabilities:
  Accounts payable                                                   $  6,066                $  8,079
  Notes payable to bank                                                18,000                  17,437
  Salaries and wages                                                      854                   1,800
  Taxes other than income taxes                                           393                   1,110
  Income taxes                                                            121
  Customer deposits                                                     1,212                   1,353
  Other                                                                 2,942                   2,829
                                                                 ------------------------------------
    Total current liabilities                                          29,588                  32,608

  Other liabilities                                                       541                     497

Stockholders' Equity
  Preferred stock, par value $.02 per share,
    authorized 5,000,000 shares; none
      issued or outstanding
  Common stock, par value $.02 per share,
    authorized 15,000,000 shares;
      issued, 7,439,732 shares in 2000
        and 7,396,232 shares in 1999                                      149                     148
  Common stock Class A Convertible, par
    value $.02 per share, authorized 3,000,000
      shares; available for issuance 2,145,536 shares;
        none issued or outstanding
  Capital in excess of par value                                       35,654                  35,568
    Retained-earnings deficit                                         (28,185)                (10,415)
    Accumulated other comprehensive loss                                 (665)                   (574)
                                                                 ------------------------------------
                                                                        6,953                  24,727
  Less cost of common stock in treasury,
    413,500 shares                                                      2,646                   2,646
                                                                 ------------------------------------
      Total stockholders' equity                                        4,307                  22,081
                                                                 ------------------------------------
  Total Liabilities and Stockholders' Equity                         $ 34,436                $ 55,186
                                                                 ====================================
</TABLE>


See accompanying notes.





                                       30
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                           Year Ended December 31
(thousands, except share data)                            2000                      1999                        1998
--------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                        <C>                        <C>
Revenues
  Product sales                                     $    18,099                $    23,800                $    32,988
  Service revenues                                       19,971                     27,642                     20,577
  Engineering revenues                                      232                        537                        284
  Other operating revenues                                                              13                        122
                                                  --------------------------------------------------------------------
    Total revenues                                       38,302                     51,992                     53,971

Costs and Expenses
  Cost of product sales                                  14,685                     16,056                     19,335
  Service expenses                                       19,408                     24,417                     14,693
  Sales and marketing expenses                            5,909                      7,980                      7,011
  Research and development expenses                       3,720                      5,688                      5,560
  General and administrative expenses                     9,867                      4,950                      3,903
  Interest expense                                        2,393                      1,276                        397
                                                  --------------------------------------------------------------------
    Total costs and expenses                             55,982                     60,367                     50,899
                                                  --------------------------------------------------------------------

Operating income (loss)                                 (17,680)                    (8,375)                     3,072

Other income (loss), net                                    (29)                       (40)                       162
                                                  --------------------------------------------------------------------

Income (loss) before income taxes                       (17,709)                    (8,415)                     3,234

  Income tax expense (benefit)                               61                       (240)                     1,105
                                                  --------------------------------------------------------------------

Net Income (Loss)                                   $   (17,770)               $    (8,175)               $     2,129
                                                  ====================================================================


Basic earnings (loss) per share                     $     (2.53)               $     (1.17)               $      0.31
                                                  ====================================================================

Basic weighted-average shares                         7,025,064                  6,979,651                  6,921,331

Diluted earnings (loss) per share                   $     (2.53)               $     (1.17)               $      0.30
                                                  ====================================================================

Diluted weighted-average shares                       7,025,064                  6,979,651                  7,102,658
</TABLE>

See accompanying notes



                                       31
<PAGE>




SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>

                                                         Capital in                   Accumulated
                                        Common Stock      Excess of    Retained-         Other
                                   -------------------      Par        Earnings      Comprehensive     Treasury
(thousands, except share data)       Shares      Amount    Value       Deficit           Loss            Stock           Total
--------------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>           <C>     <C>         <C>             <C>              <C>           <C>
Balance January 1, 1998             7,218,455     $144    $ 35,025    $ (4,369)       $   (421)        $ (2,646)     $   27,733

Issuance of common stock upon
  Exercise of stock options           152,027        3         476                                                          479

Net income                                                               2,129                                            2,129
Currency translation adjustments                                                           (95)                             (95)
                                                                                                                    ------------
Comprehensive income                                                                                                      2,034
--------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 1998           7,370,482      147      35,501      (2,240)           (516)          (2,646)         30,246

Issuance of common stock upon
  Exercise of stock options            25,750        1          67                                                           68

Net loss                                                                (8,175)                                          (8,175)
Currency translation adjustments                                                           (58)                             (58)
                                                                                                                    ------------
Comprehensive loss                                                                                                       (8,233)
--------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 1999           7,396,232      148      35,568     (10,415)           (574)          (2,646)         22,081

Issuance of common stock upon
  Exercise of stock options            43,500        1          86                                                           87

Net loss                                                               (17,770)                                         (17,770)
Currency translation adjustments                                                           (91)                             (91)
                                                                                                                    ------------
Comprehensive loss                                                                                                      (17,861)
--------------------------------------------------------------------------------------------------------------------------------
Balance December 31, 2000           7,439,732     $149    $ 35,654    $(28,185)       $   (665)        $ (2,646)          4,307
================================================================================================================================
</TABLE>

See accompanying notes.




                                       32
<PAGE>
SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                                     Year Ended December 31
(thousands)                                                           2000                   1999                     1998
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                     <C>                     <C>
Operating Activities
  Net income (loss)                                                $(17,770)               $ (8,175)               $  2,129
  Adjustments to reconcile net income (loss)
   to net cash used by  operating activities:
    Depreciation                                                        887                   1,115                   1,392
    Amortization of customer service inventory and
       software license                                               2,400                   1,912                   1,687
    Amortization of goodwill                                          1,308                   1,251                     577
    Provision for losses on accounts receivable                       5,505                      94
    Provision for inventory obsolescence                              1,064                     229
    Deferred taxes                                                                              697                    (145)
    Changes in operating assets and liabilities:
      Accounts receivable                                             8,503                    (586)                 (6,176)
      Refundable income taxes                                         1,158                  (1,282)
      Recoverable income taxes                                          740                    (740)
      Inventories                                                    (1,578)                    450                    (618)
      Prepaid expenses and other                                        178                     112                     (51)
      Software license                                                 (174)                 (2,225)
      Accounts payable                                               (2,013)                  1,790                   2,890
      Accrued salaries and wages                                       (946)                   (424)                     49
      Taxes other than income taxes                                    (717)                    419                     (53)
      Income taxes                                                      121                     (35)                   (498)
      Deferred costs, net of revenues                                   359                     (28)                 (1,849)
      Customer deposits                                                (141)                  1,254                  (2,466)
      Other                                                             371                     699                    (442)
                                                            ---------------------------------------------------------------
    Net cash used by operating activities                              (745)                 (3,473)                 (3,574)

Investing Activities
  Business acquisitions, net of cash acquired                                                (2,111)                (12,042)
  Proceeds from the sale of plant and equipment                         215
  Purchases of plant and equipment                                     (122)                   (575)                   (557)
                                                            ---------------------------------------------------------------
    Net cash provided (used) by investing activities                     93                  (2,686)                (12,599)

Financing Activities
  Proceeds from issuance of common stock                                 87                      68                     479
  Proceeds from borrowings                                           25,686                  51,941                  22,045
  Principal payments on borrowings                                  (25,123)                (46,028)                (10,521)
                                                            ---------------------------------------------------------------
    Net cash provided by financing activities                           650                   5,981                  12,003

Decrease in cash and cash equivalents                                    (2)                   (178)                 (4,170)
Cash and Cash Equivalents at Beginning of Year                           38                     216                   4,386
                                                            ---------------------------------------------------------------
Cash and Cash Equivalents at End of Year                           $     36                $     38                $    216
                                                            ===============================================================

Supplemental Cash Flow Information
Interest paid                                                      $  2,301                $  1,229                $    320
                                                            ===============================================================
Income taxes paid                                                  $      8                $  1,183                $  1,754
                                                            ===============================================================
See accompanying notes
</TABLE>


                                       33
<PAGE>

SCAN-OPTICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE A - DESCRIPTION OF BUSINESS

The  Company   combines   technology,   experience   and  expertise  to  develop
cost-effective solutions for applications that include,  insurance,  government,
transportation,  financial and order entry. The Company's systems,  software and
services  are marketed  worldwide to  commercial  and  government  organizations
either directly by the Company's sales organization or through distributors. The
Company also markets with system  integrators and specialized  niche  suppliers.
The Company's  business is vulnerable to a number of factors beyond its control.
These  include (1) the effect of a weakening in the  domestic and  international
economies which potentially  impacts capital  investments by customers,  (2) the
cyclical  nature of funding within federal and state  government  agencies,  (3)
competition from similar products,  (4) the implementation of other technologies
which may provide  alternative  solutions,  and (5) the stability of sole source
suppliers.

Future Operations:  The accompanying consolidated financial statements have been
prepared assuming that the Company will continue as a going concern. The Company
experienced a net loss of $17.8  million in 2000,  $6.3 million of which related
to one time charges associated with various allowances for accounts  receivable,
inventories  and  an  investment  in  a  contract  manufacturing  customer.  The
operating  loss without the one time charges was $11.5 million  which  primarily
related to the completion of professional  services  integration  projects which
caused the Company to incur additional costs to complete the projects.

 At year end the Company was substantially complete on the professional services
contracts  that were the result of prior periods poor  performance.  The Company
also suffered from a shortage of liquidity, which caused various scanner systems
and parts shipments to be delayed,  which impacted revenue in the second,  third
and fourth  quarters of 2000.  On January 4, 2001 Fleet  National  Bank sold the
Company's credit agreement to Patriarch  Partners,  LLC, under which the Company
was in default at December 31, 2000 because of certain covenant  violations.  On
January 31, 2001,  the Company  amended its line of credit and received a waiver
of defaults  through July 1, 2001.  As  discussed in Note F to the  consolidated
financial  statements,  the recently signed  amendment and waiver is expected to
help the Company's  liquidity  through the 3% reduction in the interest rate and
the deferral of principal  payments until  September 30, 2001. The Company is in
the process of negotiating a total debt restructuring to meet its short-term and
long-term  capital  needs.  These  matters  raise  substantial  doubt  about the
Company's ability to continue as a going concern.

The consolidated  financial statements do not include any adjustments to reflect
the possible future effects on the  recoverability  and classification of assets
or the amounts and  classification  of  liabilities  that might  result from the
outcome of this uncertainty.


                                       34
<PAGE>
NOTE B - ACCOUNTING POLICIES

Basis  of  Presentation:  The  consolidated  financial  statements  include  the
accounts of  Scan-Optics,  Inc.  and its  subsidiaries,  all  wholly-owned.  All
intercompany  accounts  and  transactions  are  eliminated  in the  consolidated
financial statements. The preparation of financial statements in conformity with
generally accepted  accounting  principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying  notes.  While  management  believes that the estimates and related
assumptions   used  in  the  preparation  of  these  financial   statements  are
appropriate, actual results could differ from those estimates.

Cash Equivalents:  Highly liquid investments  purchased with maturities of three
months or less are considered cash equivalents.

Inventories:  Inventories are valued at the lower of cost  (first-in,  first-out
method) or market. The Company periodically reviews for obsolete and slow-moving
inventory based on historical usage,  future  requirements and anticipated spare
parts demand.

Plant  and  Equipment:  Plant  and  equipment  is  stated  on the basis of cost.
Depreciation is computed principally using the straight-line method over periods
of 3 to 10 years.  Leasehold  improvements are amortized over the useful life of
the improvements or the life of the lease, whichever is shorter.

Intangibles:  Goodwill  relating to the acquisitions  completed in 1998 and 1999
represents  the  excess  cost  over  fair  value of  tangible  and  identifiable
intangible net assets acquired.  It is amortized on a straight-line basis over 5
to 20 years.  Software  license acquired in 1999 is amortized on a straight-line
basis over 3 years.

Impairment  of  Long-Lived  Assets:  The Company  records  impairment  losses on
goodwill  and  on  long-lived   assets  used  in  operations   when  events  and
circumstances  indicate  that the assets might be impaired and the  undiscounted
cash flows  estimated  to be  generated  by those  assets are less than net book
value. The Company also evaluates the amortization periods of assets,  including
goodwill  and  other  intangible   assets,   to  determine   whether  events  or
circumstances warrant revised estimates of useful lives.

Revenue   Recognition:   Revenues   relating  to  sales  of  certain   equipment
(principally  optical  character  recognition  equipment)  are  recognized  upon
acceptance,  shipment, or installation depending on the contract specifications.
When customers,  under the terms of specific  orders or contracts,  request that
the Company  manufacture and invoice the equipment on a bill and hold basis, the
Company  recognizes  revenue  based  upon an  in-house  acceptance  test that is
certified by the customer.

Revenues  under systems  integration  and  professional  services  contracts are
recognized on the basis of the ratio of earned revenue to total contract  price,
after  considering  accumulated  costs  and  estimated  costs to  complete  each
contract or when  services have been  performed  and accepted,  depending on the
nature of the project.  Under fixed price contracts,  the Company may encounter,
and on certain contracts from time to time has encountered, cost overruns caused
by project management  problems and the


                                       35
<PAGE>

expense of hiring outside contractors to assist in project completions,  as well
as changes to previously  agreed upon project  designs.  Adjustments to contract
cost  estimates  are made in the  periods  in which  the  facts  requiring  such
revisions  become  known.  When the  estimates  indicate  a loss,  such  loss is
provided for when identified.

Revenues from maintenance services are recognized as earned.

Income Taxes:  Deferred  income taxes are provided for  differences  between the
income tax and the financial  reporting  bases of assets and  liabilities at the
statutory tax rates that will be in effect when the  differences are expected to
reverse. A valuation allowance for deferred tax assets is recorded to the extent
the Company cannot  determine that the ultimate  realization of net deferred tax
assets is more  likely  than not.  In making  such  determination,  the  Company
considers   estimated  future  reversals  of  existing  temporary   differences,
estimated future earnings and available tax planning  strategies.  To the extent
that the estimates of these items are reduced or not realized, the amount of the
deferred tax assets considered realizable could be adversely affected.

Stock Based  Compensation:  The Company  generally  grants stock  options to key
employees and members of the Board of Directors  with an exercise price equal to
the fair  value of the shares on the date of grant.  The  Company  accounts  for
stock option grants in accordance with APB Opinion No. 25,  Accounting for Stock
Issued to Employees,  and,  accordingly,  recognizes no compensation expense for
the stock  option  grants.  Therefore,  the Company  has elected the  disclosure
provisions only of FASB Statement No. 123.

Earnings  (Loss)  Per  Share:  Basic and  diluted  earnings  (loss) per share is
calculated in accordance  with FASB Statement No. 128,  Earnings Per Share.  For
2000 and  1999,  the  computation  of  diluted  earnings  (loss)  per  share was
antidilutive,  therefore,  the amounts  reported for basic and diluted  earnings
(loss) per share were the same.

Foreign Currency  Translation:  The financial statements of foreign subsidiaries
have been translated into U.S. dollars in accordance with FASB Statement No. 52,
Foreign  Currency  Translation.  All balance sheet accounts have been translated
using the  exchange  rates in effect at the  balance  sheet date.  Statement  of
operations  amounts have been translated using the average exchange rate for the
year.  The gains and losses  resulting  from the changes in exchange  rates from
year to year have been  reported in other  comprehensive  loss,  a component  of
Stockholders' Equity.

Reclassifications:  Certain  1999 and 1998  amounts  have been  reclassified  to
conform to the current year presentation.


NOTE C- Acquisition Activities

The Company completed two acquisitions  during June 1998. The first was Southern
Computer  Systems (SCS),  a privately held company,  for $7 million in cash. The
Company  acquired cash and accounts  receivable of $.4 million,  fixed assets of
$.3 million and other  assets of $.1 million.  The Company also assumed  certain
liabilities  as follows:  accounts  payable of $.5 million,  salary and benefits
accruals  of $.2  million,  deferred  revenue of $.1  million,  note  payable to
Scan-Optics,  Inc. of $.5 million,  acquisition  related expenses for investment
banker  and  legal  services  of $.4  million  and  bank  debt of $1.4  million.
Immediately  following the closing,  the bank debt was repaid. The operations of
SCS are included in the


                                       36
<PAGE>

consolidated  statement  of  operations  from  the  date  of  acquisition.   The
transaction  was accounted for as a purchase and the excess cost over fair value
of the net assets acquired of $9.2 million is being amortized over a twenty year
period. The proforma unaudited results of operations for the year ended December
31, 1998,  assuming  consummation  of the purchase as of January 1, 1997, are as
follows:

                                                        December 31
(thousands, except per share amounts)                      1998
--------------------------------------------------------------------------

Total revenue                                           $  55,732
Net loss                                                  (1,459)
Basic earnings (loss) per share                             (.21)
Diluted earnings (loss) per share                       $   (.21)

The Company entered into consulting and non-competition  agreements with the two
principals of SCS. The agreements call for eight  quarterly  payments of $50,000
per principal,  beginning in the fourth quarter of 1998. The agreements  provide
for consulting  services to be performed by the principals as well as preventing
the principals from becoming directly involved with a competing  business in the
Image Data Capture  marketplace.  The amount of the quarterly  payments is being
amortized over a two-year period.

The second  acquisition was the maintenance  division of Access  Corporation for
$3.3 million in cash. The Company acquired  accounts  receivable of $.5 million.
The Company  also assumed a liability  for  deferred  revenue of $.5 million and
acquisition  related  expenses for  investment  banker and legal services of $.2
million.  The operations of the maintenance  division of Access  Corporation are
included  in  the  consolidated   statement  of  operations  from  the  date  of
acquisition. The transaction was accounted for as a purchase and the excess cost
over fair value of the net assets  acquired of $3.5  million is being  amortized
over a five year period.

During June 1999,  the Company  completed the  acquisition of the product rights
and  certain  assets of the  Photomatrix  Imaging  Corporation's  subsidiary  of
Photomatrix,  Inc.  for $2.1  million in cash.  The  Company  acquired  accounts
receivable  net of reserves of $1 million,  manufacturing  and customer  service
inventory  net of reserves of $1.2 million and other assets of $.1 million.  The
Company also assumed  liabilities for accounts payable of $.8 million,  deferred
revenue  of $.5  million,  salary  and  benefits  accruals  of $.2  million  and
acquisition  related expenses of $.3 million.  The acquisition was accounted for
as a purchase and the operations are included in the  consolidated  statement of
operations from the date of acquisition.  The Company reported  goodwill related
to the  transaction  of $1.6  million,  which will be amortized  over an average
period  of  twelve  and  one-half  years.  Subsequent  to the  acquisition  date
adjustments of $.6 million have been made to decrease goodwill to $1 million.

The Company determines the amount of goodwill and the amortization  period based
upon a review of the acquired business and its earnings potential.


NOTE D - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS

Amounts billed under  contracts in progress and included in accounts  receivable
were $1.3 million and $.5 million at December  31, 2000 and 1999,  respectively.
Unbilled  amounts in  accounts  receivable  were $.9  million  and $5 million at
December 31, 2000 and 1999,  respectively  and are recoverable from the


                                       37
<PAGE>

customer upon completion of the phase or milestone.  The Company  estimates that
substantially all unbilled amounts will be collected in 2001.



NOTE E- INVENTORIES

The components of inventories were as follows:
                                                       December 31
(thousands)                                        2000             1999
------------------------------------------------------------------------
Finished goods                                 $    196         $    363
Work-in-process                                     846            1,927
Service parts                                     4,552            4,429
Materials and component parts                     3,304            3,314
                                               -------------------------
                                               $  8,898         $ 10,033
                                               =========================


NOTE F - CREDIT ARRANGEMENTS

On May 10, 1999, the Company amended its credit agreement (the "Agreement") with
a bank to extend the  maturity  date to May 10, 2002 and to reduce the line from
$13  million  to $10  million.  The  unused  portion of the line is subject to a
commitment  fee of 3/8% per annum.  The available  balance on the line of credit
was $.5 million and $2.1  million at December  31, 2000 and  December  31, 1999,
respectively.  The weighted average interest rate on borrowings  during 2000 and
1999 was 13.2% and 8.3%, respectively.

Additionally,  on May 10,  1999,  a  five-year  term  loan in the  amount of $10
million was established to better match the cash  expenditures  for acquisitions
with the cash flow that results from the acquired  businesses.  The  outstanding
balance on the term loan at December 31, 2000 and 1999 was $8.5 million and $9.5
million,  respectively, all of which is classified as a current liability on the
consolidated  balance  sheet.  Both the line of  credit  and the term  loan bore
interest at prime through  March 24, 2000, at which point the rate  increased to
prime plus 5%.

Fleet National Bank sold the Agreement to Patriarch Partners,  LLC on January 4,
2001. The Agreement contains  covenants which,  among other things,  require the
maintenance of specified  working  capital,  debt to equity  ratios,  net income
levels,  tangible net worth levels and backlog levels.  The Company entered into
an amendment and waiver  agreement with Patriarch  Partners,  LLC on January 31,
2001 that waived  defaults on the revolver and term loans  through July 1, 2001.
The amendment also reduced the interest rate to prime plus 2% effective  January
30,  2001.   The  Company  is  in  the  process  of  negotiating  a  total  debt
restructuring to meet its short-term and long-term capital needs.  These matters
raise  substantial  doubt  about the  Company's  ability to  continue as a going
concern.  If  negotiations  on the  revision  of the  Agreement  with  Patriarch
Partners LLC are not complete by the end of the second quarter, the Company will
continue to negotiate with other bank and finance  companies,  as well as review
other business and financing options.

The carrying value of the notes payable to bank  approximates its fair value and
is secured by all of the Company's assets.



                                       38
<PAGE>
NOTE G- CAPITAL STOCK

The Board of Directors is authorized to issue shares of the Company's  preferred
stock in  series,  to  establish  from  time to time the  number of shares to be
included  in each series and to fix the  designation,  powers,  preferences  and
other  terms and  conditions  with  respect to such  stock.  No shares have been
issued to date.

At December 31, 2000, the Company had reserved  1,242,955 shares of common stock
for the issuance or exercise of stock options.  There are no shares reserved for
the exercise of warrants.

Class A Convertible  stock has the same rights as common stock,  except that its
holders may not vote for the election of directors,  and it is convertible  into
common stock on a share for share basis.  On September 2, 1994, all  outstanding
shares of Class A Convertible  stock were  converted to common stock.  No shares
were outstanding at December 31, 2000 and 1999.


NOTE H - STOCK OPTION PLANS

The Company has elected to follow  Accounting  Principles  Board Opinion No. 25,
Accounting   for  Stock   Issued  to   Employees   (APB  No.  25)  and   related
interpretations  in accounting for its stock options.  Under APB No. 25, because
the exercise  price of the Company's  stock  options  equals market price of the
underlying stock on the date of grant, no compensation expense is recognized.

The Company has five stock option  plans for key  employees  and board  members.
Options  granted under the plans are for a period of ten years and at prices not
less than 85% of the fair market  value of the shares at date of grant.  Options
for employees are not  exercisable  for one year following the date of grant and
then are exercisable in such installments during the period prior to expiration,
as the Stock  Option  and  Executive  Compensation  Committee  shall  determine.
Options  for  Directors  are not  exercisable  until six months  after the grant
thereof. Options may be exercised from time to time, in part or as a whole, on a
cumulative  basis as determined  by the Stock Option and Executive  Compensation
Committee under all stock option plans.

The following  schedule  summarizes the changes in stock options for each of the
three years in the period ended December 31, 2000:


<TABLE>
<CAPTION>
                                                           Number of          Option Price
                                                            Shares              Per Share
---------------------------------------------------------------------------------------------
<S>                                                           <C>            <C>
Outstanding January 1, 1998 (678,688 exercisable)            817,393        $1.50  to  $9.19
  Granted                                                     35,000         5.69  to   9.19
  Exercised                                                 (152,027)        2.13  to   3.75
  Canceled                                                   (11,933)        2.13  to   6.38
                                                           ---------------------------------
Outstanding December 31, 1998 (531,420 exercisable)          688,433         1.50  to   9.19


                                       39
<PAGE>

1999 Activity
  Granted                                                    140,000         3.25  to   3.50
  Exercised                                                  (25,750)        2.00  to   3.25
  Canceled                                                   (47,700)        2.00  to   9.19
                                                           ---------------------------------
Outstanding December 31, 1999 (560,457 exercisable)          754,983         1.50  to   9.19

2000 Activity
  Granted                                                    561,700          .31  to   1.06
  Surrendered                                                (42,500)        6.38  to   9.19
  Exercised                                                  (43,500)        2.00  to   2.00
  Canceled                                                  (108,550)        1.06  to   5.75
                                                          ----------------------------------
Outstanding December 31, 2000 (545,245 exercisable)        1,122,133         $.31  to  $9.19
                                                          ==================================
</TABLE>



At December 31, 2000 there were  120,822  options  available  for grant of which
120,000 were reserved for the Directors.

The  weighted-average  fair value of options  granted was $.46,  $3.45 and $6.21
during  2000,  1999,  and 1998,  respectively.  The  weighted-average  remaining
contractual life of the options outstanding at December 31, 2000 was 8 years.

Pro forma information regarding net income and earnings per share is required by
FASB Statement No. 123, and has been  determined as if the Company had accounted
for its stock  options under the fair value method of that  Statement.  The fair
value of these options was estimated at the date of grant using a  Black-Scholes
option pricing model.

Option  valuation  models  require  the input of highly  subjective  assumptions
including  the expected  stock price  volatility.  The  assumptions  used in the
valuation model were: risk free interest rate - 7%, expected life - 10 years and
expected volatility of .80 to 1.02.

Because the Company's stock options have characteristics significantly different
from  those of traded  options,  and  because  changes in the  subjective  input
assumptions  can  materially  affect the fair value  estimate,  in  management's
opinion,  the  existing  models do not  necessarily  provide a  reliable  single
measure of the fair value of its stock options.

For the purpose of pro forma disclosures,  the estimated fair value of the stock
options is expensed ratably over the vesting period,  which is 36 months for key
employees  and 6 months  for the Board of  Directors.  The  Company's  pro forma
information follows:

<TABLE>
<CAPTION>
                                                                   December 31
(thousands, except per share amounts)                    2000          1999          1998
-----------------------------------------------------------------------------------------------
<S>                                                  <C>           <C>               <C>
Net income (loss), as reported                       $(17,770)     $ (8,175)         $ 2,129
Stock option expense                                      (51)         (693)            (563)
                                                     ------------------------------------------
Pro forma net income (loss)                          $(17,821)     $ (8,868)         $ 1,566
                                                     ==========================================







                                       40
<PAGE>

Basic earnings (loss) per share, as reported         $  (2.53)     $  (1.17)         $   .31
Stock option expense                                     (.01)         (.10)            (.08)
                                                     ------------------------------------------
Pro forma basic earnings (loss) per share            $  (2.54)     $  (1.27)         $   .23
                                                     ==========================================

Diluted earnings (loss) per share, as reported       $  (2.53)     $  (1.17)         $   .30
Stock option expense                                     (.01)         (.10)            (.08)
                                                     ------------------------------------------
Pro forma diluted earnings (loss) per share          $  (2.54)     $  (1.27)         $   .22
                                                     ==========================================
</TABLE>


NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS


During 1998, the Company entered into a $200,000 custom development project with
a specific  customer.  The project involved adding fluorescent bar code printing
and reading to the Series 9000 product and adding additional  stacker modules to
accommodate the document sorting  requirement.  The Company recorded all revenue
related to this  development  agreement in 1998.  These revenues  offset related
costs incurred to develop the modifications  and enhancements.  The ownership of
the technologies created as a result of this development  agreement remains with
the Company. No royalties or other considerations are required as a part of this
agreement.

During 1999,  the Company  entered into four custom  development  agreements for
specific   customers.   A  $125,000   agreement   involved  the  development  of
localization  software for screen displays in Japanese. A $115,000 agreement was
for recognition  enhancements to a current product. A $75,000 agreement involved
enhancements for the reading of Japanese stock certificates. A $58,000 agreement
involved  software  developments  for the  processing  of mortgage  payments and
taxes. The Company recorded all revenue related to these development  agreements
in 1999. These revenues offset the related costs incurred for this  development.
The ownership of these  technologies  remains with the Company.  No royalties or
other considerations are required as part of these agreements.

During  2000,  the  Company  completed  a  number  of small  custom  development
contracts for specific customers resulting in approximately  $200,000 of revenue
recognized  during the year. The Company  recorded all revenue  related to these
development agreements in 2000. These revenues offset the related costs incurred
for this  development.  The  ownership  of these  technologies  remains with the
Company.  No  royalties  or other  considerations  are required as part of these
agreements.


NOTE J - EMPLOYEE BENEFITS

The Company  maintains a Retirement  Savings Plan for United  States  employees.
Under this plan,  all  employees  may  contribute up to 15% of their salary to a
retirement  account up to the maximum amount  allowed by law.  Starting in 1997,
the Company  contributed  an amount equal to 50% of the first 6%  contributed by
the  participant.  The  Company's  contributions  to this  plan  were  $306,000,
$374,000 and $329,000, in 2000, 1999 and 1998, respectively.

The Company  sponsors an Employee  Stock  Ownership  Plan (the "Plan")  covering
substantially  all  full-time  employees.  The  Plan,  which is a tax  qualified
employee  benefit plan,  was adopted by the Board of Directors of the Company in
1988 to provide retirement benefits for employees.  The Plan borrowed $1,325,000
to  purchase   260,000  shares  of  the  Company's  stock  to  be  allocated  to
participants ratably


                                       41
<PAGE>

over a ten year  period.  The ESOP loan was  guaranteed  by the  Company and the
outstanding balance of the loan was repaid in 1991. The Company did not allocate
any  additional  shares to the Plan in 2000 or 1999.  At December 31, 1998,  all
shares had been  allocated.  The  Company,  at its  discretion,  may make annual
allocations  to the Plan in the future.  There were no  expenses  related to the
Plan in 2000, 1999 and 1998.


NOTE K - INCOME TAXES

At December  31, 2000,  the Company has U.S.  federal and state  operating  loss
carryforwards of approximately  $17,490,000 and $19,980,000,  respectively.  The
U.S. federal and state net operating loss carryforwards  expire through 2020. At
December  31,  2000,  the Company has  approximately  $575,000,  $3,270,000  and
$800,000 of net operating loss  carryforwards for Canada, the United Kingdom and
Germany,  respectively,  which begin to expire in 2008. For financial  reporting
purposes,  a valuation  allowance  has been  recorded for 2000 and 1999 to fully
offset  deferred tax assets  relating to U.S.  federal,  state,  and foreign net
operating loss carryforwards and other temporary differences.













                                       42
<PAGE>


Income (loss) before income taxes is set forth in the following tabulation:

<TABLE>
<CAPTION>
                                                 Year Ended December 31
(thousands)                                2000             1999            1998
-----------------------------------------------------------------------------------
<S>                                      <C>              <C>              <C>
Domestic                                 $(17,436)        $ (7,806)        $  3,228
Foreign                                      (273)            (609)               6
                                     ----------------------------------------------
Income (loss) before income taxes        $(17,709)        $ (8,415)        $  3,234
                                     ==============================================


Income taxes (benefit) are summarized as follows:
                                                   Year Ended December 31
(thousands)                                 2000             1999             1998
------------------------------------------------------------------------------------


Current (benefit):
  Federal                                                 $   (956)        $    944
  State                                  $     49               26              311
  Foreign                                      12               (7)              (5)
                                       --------------------------------------------
Total current (benefit)                        61             (937)           1,250
                                       --------------------------------------------
Deferred (benefit):
  Federal                                                      620             (129)
  State                                                         77              (16)
                                      ---------------------------------------------
Total deferred (benefit)                                       697             (145)
                                       --------------------------------------------

                                         $     61         $   (240)        $  1,105
                                      =============================================
</TABLE>

Significant components of the Company's deferred tax liabilities and assets were
as follows:
<TABLE>
<CAPTION>
                                                                             December 31
(thousands)                                                              2000           1999
-----------------------------------------------------------------------------------------------
<S>                                                                   <C>              <C>
 Deferred tax assets:
   Net operating loss carryforward                                    $  8,556         $  5,671
   Alternative minimum tax credit carryforward                             168              168
   Depreciation                                                             92               92
   Charitable contribution carryforward                                     53
   Inventory valuation                                                     553              163
   Inventory                                                               180              101
   Deferred maintenance revenue                                                               6
   Accounts receivable reserves                                          2,057              113
   Goodwill                                                                206               71
   Revenue recognition - systems undergoing acceptance testing                                8
   Vacation accrual                                                        216              237
   Other                                                                   156               13
                                                                      -------------------------
      Total gross deferred tax assets                                   12,237            6,643











                                       43
<PAGE>



Deferred tax liabilities:
   Revenue recognition - milestone and retainer contracts                                  (989)
   Depreciation and other                                                 (449)            (263)
                                                                      -------------------------
      Total gross deferred tax liabilities                                (449)          (1,252)

Valuation allowance                                                    (11,788)          (5,391)
                                                                      -------------------------
      Net deferred tax asset                                          $     --         $     --
                                                                      =========================
</TABLE>


A reconciliation of the statutory tax rate to the effective rate is as follows:

                                                     Year Ended December 31
                                                2000         1999        1998
-------------------------------------------------------------------------------
Statutory federal income tax rate               (34)%        (34)%         34%
  State income taxes, net of federal benefit     .3            1            7%
  Adjustments to prior year taxes                             (3)
  Foreign sales corporation benefit                                        (9)
  Foreign income taxes                           .1            2
  Net operating loss carryforward                34           33
  Other                                                       (2)           2
                                              --------------------------------
Effective tax rate                               .4%          (3)%         34%
                                              ================================


NOTE L - LEASE COMMITMENTS

The  Company's  principal  lease  commitment  is for its  corporate  office  and
manufacturing facility in Manchester,  Connecticut. The Manchester lease expires
on December 31, 2006.  Minimum  rental  payments for all  noncancelable  leases,
which are  operating  leases  with terms equal to or in excess of one year as of
December 31, 2000, are as follows:
                                                         Minimum Rental
(thousands)                                                 Payments
-----------------------------------------------------------------------

           2001                                            $    979
           2002                                                 824
           2003                                                 659
           2004                                                 414
           2005                                                 426
           Thereafter                                           755
                                                             ------

           Total minimum lease payments                     $ 4,057
                                                            =======

Rental  expense  for the years  ended  December  31,  2000,  1999,  and 1998 was
$1,114,000, $1,062,000, and $865,000, respectively.



                                       44
<PAGE>


NOTE M - CONTINGENCIES

There is one lawsuit currently  pending against the Company.  This lawsuit is in
reaction to a lawsuit filed by the Company  against the plaintiff.  Although the
ultimate  outcome is  uncertain,  based on currently  known  facts,  the Company
believes that it has strong defenses  against this lawsuit and the resolution of
this matter will not have a material  adverse effect on the Company's  financial
position or annual operating results.


NOTE N - SEGMENT INFORMATION

Business  segment data and geographic  area data for the years ended 2000,  1999
and 1998 as  included  in Item 1 of this  report are an  integral  part of these
financial statements.


NOTE O - BILL AND HOLD TRANSACTIONS

Revenues relating to sales of certain equipment  (principally  optical character
recognition equipment) are recognized upon acceptance, shipment, or installation
depending on the contract  specifications.  When  customers,  under the terms of
specific orders or contracts,  request that the Company  manufacture and invoice
the  equipment on a bill and hold basis,  the Company  recognizes  revenue based
upon an in-house  acceptance  test that is certified by the  customer.  Revenues
recorded during 2000, 1999 and 1998 included bill and hold  transactions of $1.7
million,  $5.6  million  and $3.7  million,  respectively.  Accounts  receivable
included bill and hold  receivables  of $.4 million and $3.5 million at December
31, 2000 and 1999, respectively.










                                       45
<PAGE>



NOTE P - EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per
share:

<TABLE>
<CAPTION>
                                                                           December 31
(thousands, except share data)                          2000                   1999                 1998
-----------------------------------------------------------------------------------------------------------
<S>                                                 <C>                   <C>                   <C>
Numerator:
      Net Income (Loss)                             $   (17,770)          $    (8,175)          $     2,129
                                                  =========================================================


Denominator:
      Denominator for basic earnings
      per share (weighted-average shares)             7,025,064             6,979,651             6,921,331

      Effect of dilutive securities:
           Employee stock options                                                                   181,327

      Denominator for diluted earnings
      per share (adjusted weighted-average
      shares and assumed
      Conversions)                                    7,025,064             6,979,651             7,102,658
                                                  =========================================================

Basic earnings (loss) per share                     $     (2.53)          $     (1.17)          $       .31
                                                  =========================================================

Diluted earnings (loss) per share                   $     (2.53)          $     (1.17)          $       .30
                                                  =========================================================
</TABLE>








                                       46
<PAGE>



NOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly  results of operations for the years
ended December 31, 2000 and 1999.


<TABLE>
<CAPTION>
(thousands, except per share amounts)                March           June           September       December
--------------------------------------------------------------------------------------------------------------
<S>                                               <C>              <C>              <C>              <C>
2000
Revenues                                          $ 11,102         $  9,924         $ 10,015         $  7,261
Cost of product sales and service expenses           9,186            8,847            7,719            8,341
Net loss                                            (2,275)          (3,256)          (1,781)         (10,458)
Basic earnings (loss) per share                       (.32)            (.46)            (.25)           (1.49)
Diluted earnings (loss) per share                 $   (.32)        $   (.46)        $   (.25)        $  (1.49)


1999
Revenues                                          $ 13,232         $ 14,829         $ 12,456         $ 11,475
Cost of product sales and service expenses           9,019            9,658           10,524           11,272
Net income (loss)                                       80               63           (1,963)          (6,355)
Basic earnings (loss) per share                        .01              .01             (.28)            (.91)
Diluted earnings (loss) per share                 $    .01         $    .01         $   (.28)        $   (.91)
</TABLE>


Fourth  quarter 2000 net loss of $10.5  million  includes  charges to expense of
$6.3 million or $.90 per share.  The major  components of these charges  include
$5.3 million of accounts receivable allowances for various accounts, $.7 million
for inventories and an investment in a contract manufacturing  customer, and $.3
million of inventory reserves.

The fourth  quarter of 1999 includes a $1.3 million  reduction of the income tax
benefit  recorded  for the nine month  period  ended  September  30,  1999 and a
valuation allowance was established for $.7 million for net deferred tax assets.











                                       47
<PAGE>




ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE


None.





                                    PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information  pertaining to Directors and  additional  information  pertaining to
Executive  Officers is included  under the captions  "Governance of the Company"
and  "Compliance  with Section 16(a) of the Securities  Exchange Act of 1934" in
the Company's  definitive proxy statement for the Annual Meeting of Stockholders
to be held on May 17, 2001 and is  incorporated  herein by reference  and made a
part hereof.

ITEM 11 - EXECUTIVE COMPENSATION

This information is included in the Company's definitive proxy statement for the
Annual Meeting of  Stockholders  to be held on May 17, 2001 and is  incorporated
herein by reference.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

This information is included under the captions  "Security  Ownership of Certain
Beneficial  Owners"  and  "Share  Ownership  of  Management"  in  the  Company's
definitive  proxy statement for the Annual Meeting of Stockholders to be held on
May 17, 2001 and is incorporated herein by reference.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

This  information is included under the caption  "Certain  Transactions"  in the
Company's  definitive  proxy statement for the Annual Meeting of Stockholders to
be held on May 17, 2001 and is incorporated herein by reference.











                                       48
<PAGE>



                                     PART IV

ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K

(a) The following  consolidated  financial  statements and report of independent
auditors of the Company and its subsidiaries are included in Item 8:

         (1)  Report of Independent Auditors

              Consolidated Balance Sheets at December 31, 2000 and 1999

              Consolidated Statements of Operations for the years ended
              December 31, 2000, 1999 and 1998

              Consolidated Statements of Stockholders' Equity for the
              years ended December 31, 2000, 1999 and 1998

              Consolidated Statements of Cash Flows for the years ended
              December 31, 2000, 1999 and 1998

              Notes to Consolidated Financial Statements - December 31, 2000

         (2)  The following consolidated financial statement schedule is
              included in Item 14(a):

                    Schedule II -- Valuation and Qualifying Accounts


All other  schedules for which  provision is made in the  applicable  accounting
regulation of the Securities and Exchange  Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.

         (3)  Listing of Exhibits

              *3.1(a)       Certificate of Incorporation,  including  amendments
                            thereto  (filed  as  Exhibit  3.1 to  the  Company's
                            Registration   Statement  on  Form  S-1,   File  No.
                            2-70277).

              *3.1(b)       Amendments to Certificate of  Incorporation  adopted
                            May 17, 1984,  included in Exhibits A, B, C and D in
                            the Company's  Proxy  Statement dated April 17, 1984
                            for the Annual Meeting of Stockholders  held May 17,
                            1984.

              *3.1(c)       Amendment  to Article  Tenth of the  Certificate  of
                            Incorporation included as Exhibit A in the Company's
                            Proxy  Statement dated April 16, 1987 for the Annual
                            Meeting of Stockholders held May 19, 1987.

              *3.2(a)       By-laws of the Company  (filed as Exhibit 3.2 to the
                            Company's  Registration  Statement on Form S-1, File
                            No. 2-70277).






                                       49
<PAGE>

              *3.2(b)       Amendments to By-laws of the Company adopted May 17,
                            1984,  included in Exhibits A and B in the Company's
                            Proxy  Statement dated April 17, 1984 for the Annual
                            Meeting of Stockholders held May 17, 1984.

              *3.2(c)       Amendment  to By-laws of the Company  adopted at the
                            meeting of the Board of  Directors  on  January  28,
                            1991,  included as Exhibit  3.2(c) in the  Company's
                            Annual  Report on Form 10K filed for the year  ended
                            December 31, 1991.

              *+10.1        The    Scan-Optics,    Inc.   1979   Incentive   and
                            Non-Qualified  Stock Option Plan included in Exhibit
                            B in the  Company's  Proxy  Statement  dated June 8,
                            1979 for the Annual Meeting of Stockholders  held on
                            June 27, 1979.

              *+10.2        The    Scan-Optics,    Inc.   1984   Incentive   and
                            Non-Qualified  Stock Option Plan included in Exhibit
                            E in the Company's  Proxy  Statement dated April 19,
                            1984 for the Annual Meeting of Stockholders  held on
                            May 17, 1984.

              *+10.3        The    Scan-Optics,    Inc.   1987   Incentive   and
                            Non-Qualified  Stock Option Plan included in Exhibit
                            B in the Company's  Proxy  Statement dated April 16,
                            1987 for the Annual Meeting of Stockholders  held on
                            May 19, 1987.

              *+10.4        The    Scan-Optics,    Inc.   1990   Incentive   and
                            Non-Qualified  Stock Option Plan included in Exhibit
                            A in the Company's  Proxy  Statement dated April 30,
                            1990 for the Annual Meeting of Stockholders  held on
                            June 12, 1990.

              *+10.5        The  Scan-Optics,  Inc.  1990 Stock  Option Plan for
                            Outside  Directors  included  in  Exhibit  B in  the
                            Company's  Proxy  Statement dated April 30, 1990 for
                            the Annual Meeting of Stockholders  held on June 12,
                            1990.

              *+10.6        The    Scan-Optics,    Inc.   1990   Incentive   and
                            Non-Qualified  Stock Option Plan amendment  included
                            as Item 2 in the  Company's  Proxy  Statement  dated
                            April   14,   1994  for  the   Annual   Meeting   of
                            Stockholders held on May 18, 1994.

              *+10.7        The  Scan-Optics,  Inc.  1990 Stock  Option Plan for
                            Outside  Directors  amendment  included as Item 2 in
                            the Company's  Proxy  Statement dated April 15, 1996
                            for the Annual Meeting of  Stockholders  held on May
                            15, 1996.

              *+10.8        The    Scan-Optics,    Inc.   1999   Incentive   and
                            Non-Qualified  Stock Option Plan included in Exhibit
                            A in the Company's  Proxy  Statement  dated April 8,
                            1999 for the Annual Meeting of Stockholders  held on
                            May 20, 1999.

              *+10.9        Employment  agreement,  effective as of December 31,
                            1996, between Scan-Optics,  Inc. and James C. Mavel,
                            included as Exhibit  10.10 in the  Company's  Annual
                            Report  on  Form  10-K  filed  for  the  year  ended
                            December 31, 1996.

              *+10.10       Executive  severance  agreement  between  Joseph  P.
                            Crouch and  Scan-Optics,  Inc.  dated  November  15,
                            1999,  is filed as  Exhibit  10.10 in the  Company's
                            Annual  Report on Form 10-K filed for the year ended
                            December 31, 1999.



                                       50
<PAGE>

              *+10.11       Executive  severance  agreement  between Marianna C.
                            Emanuelson and Scan-Optics,  Inc. dated November 17,
                            1997,  is filed as  Exhibit  10.11 in the  Company's
                            Annual  Report on Form 10-K filed for the year ended
                            December 31, 1999.

              *+10.12       Executive  severance  agreement  between  Richard C.
                            Goyette and  Scan-Optics,  Inc.  dated  November 17,
                            1997,  is filed as  Exhibit  10.12 in the  Company's
                            Annual  Report on Form 10-K filed for the year ended
                            December 31, 1999.

              *+10.13       Executive severance agreement between Joel K. Howser
                            and  Scan-Optics,  Inc.  dated November 17, 1997, is
                            filed  as  Exhibit  10.13  in the  Company's  Annual
                            Report  on  Form  10-K  filed  for  the  year  ended
                            December 31, 1999.

              *+10.14       Executive  severance  agreement  between Clarence W.
                            Rife and Scan-Optics,  Inc. dated November 17, 1997,
                            is filed as Exhibit  10.14 in the  Company's  Annual
                            Report  on  Form  10-K  filed  for  the  year  ended
                            December 31, 1999.

              *+10.15       Executive  severance  agreement  between  Michael J.
                            Villano and  Scan-Optics,  Inc.  dated  November 17,
                            1997,  is filed as  Exhibit  10.15 in the  Company's
                            Annual  Report on Form 10-K filed for the year ended
                            December 31, 1999.

              *22.          List of  subsidiaries  of the  Company,  included as
                            Exhibit 10.8 in the Company's  Annual Report on Form
                            10-K filed for the year ended December 31, 1999.

              23.           Consent of Independent Auditors.

     * Exhibits so marked  have  heretofore  been filed by the Company  with the
Securities and Exchange Commission and are incorporated herein by reference.

     + Management  contract for compensatory plan or arrangement  required to be
filed as an exhibit to this form pursuant to Item 14(c) of this report.

         (b) Reports on Form 8-K

              No report on Form 8-K was filed for the quarter ended December 31,
              2000.

         (c) Exhibits

              The exhibits required by this item are included herein.

         (d) Financial Statement Schedule

              The response to this portion of Item 14 is submitted as a separate
              section of this report.










                                       51
<PAGE>


                                   SIGNATURES

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

                                SCAN-OPTICS, INC.
                                   Registrant

                                 By:  /s/ James C. Mavel
                                     ----------------------------------------
                                   James C. Mavel
                                   Chairman, Chief Executive Officer,
                                   President and Director
                                   Date: March 26, 2001

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 in
the capacities and on the dates indicated.

/s/ James C. Mavel
---------------------------
James C. Mavel                              Chairman, Chief Executive Officer,
                                            President and Director
                                            (Principal Executive Officer)
                                            Date:        March 26, 2001

/s/ Michael J. Villano
---------------------------
Michael J. Villano                          Chief Financial Officer, Vice
                                            President and Treasurer
                                            (Principal Financial and
                                            Accounting Officer)
                                            Date:        March 26, 2001

/s/ Logan Clarke, Jr.
---------------------------
Logan Clarke, Jr.                           Director     March 26, 2001

/s/ Richard J. Coburn
---------------------------
Richard J. Coburn                           Director     March 26, 2001

/s/ E. Bulkeley Griswold
---------------------------
E. Bulkeley Griswold                        Director     March 26, 2001

/s/ Lyman C. Hamilton, Jr.
---------------------------
Lyman C. Hamilton, Jr.                      Director     March 26, 2001

/s/ John J. Holton
---------------------------
John J. Holton                              Director     March 26, 2001

/s/ Robert H. Steele
---------------------------
Robert H. Steele                            Director     March 26, 2001




A majority of the Directors



                                       52
<PAGE>



<TABLE>
<CAPTION>
                                                                                                       SCHEDULE II



                                                     SCAN-OPTICS, INC. AND SUBSIDIARIES
                                                     VALUATION AND QUALIFYING ACCOUNTS
                                             THREE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
                                                                (thousands)

                  COLUMN A                      COLUMN B                  COLUMN C                     COLUMN D        COLUMN E
                                                                         Additions
                                                              ---------------------------------
                                               Balance at       Charged to       Charged to                           Balance at
                                                Beginning        Costs and         Other                                End of
              Description                       Of Period        Expenses        Accounts             Deductions        Period
----------------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>              <C>             <C>     <C>          <C>                <C>
Year ended December 31, 2000                   $  308           $  5,505        $   13  (2)          $  211(1)          $  5,615
      Reserve for doubtful accounts
          (billed and unbilled)

Year ended December 31, 1999:                  $  206           $     94        $   56  (2)          $   48 (1)         $    308
      Reserve for doubtful accounts

Year ended December 31, 1998:                  $  104           $               $  149  (2)          $   47 (1)         $    206
      Reserve for doubtful accounts

<FN>
(1) Uncollectible accounts written off, net of recoveries.
(2)  Represents reclassifications from other accounts.
</FN>
</TABLE>

The required  information  regarding  the  valuation  allowance for deferred tax
assets is included in Note K.











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