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, 2004
(   ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
      Exchange Act of 1934
For the transition  period from  __________________________
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. [ ]

Indicate  by check mark  whether  the  registrant  is an  accelerated  filer (as
defined in Exchange Act Rule 12b-2) (__) YES (X) NO

The aggregate  market value of the voting and  non-voting  common equity held by
non-affiliates  computed by reference  to the price at which  common  equity was
last sold, or the average bid and asked price of such common  equity,  as of the
last day of the  registrant's  most recently  completed  second fiscal  quarter:
$2,810,493 as of June 30, 2004.

The number of shares of common stock,  $.02 par value,  outstanding  as of March
22, 2005 was 41,451,577.


                                       1
<PAGE>




DOCUMENTS INCORPORATED BY REFERENCE
-----------------------------------

Portions of the definitive Proxy Statement,  relating to the 2005 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

Part III-Item 14 - Principal Accountant Fees and Services




                                       2
<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,  develops  and  implements  transaction  and  information
management  work  processes.  Adept  with  sophisticated   recognition,   image,
workflow,  network  and  data  base  technologies,  the  Company  provides  cost
effective,  high quality solutions that match the unique information  processing
requirements of its sophisticated client base.

The Company is a leader in developing,  applying and  supporting  technology for
the conversion of analog  information  into digital.  Historically the Company's
research  and  development  activity  has  focused  on  improving  accuracy  and
performance  of the high speed image and "OCR" (optical  character  recognition)
scanning platforms.  Microsoft development  environments on Intel platforms have
enhanced the Company's  strength in developing  and  supporting  complex  system
integration projects.  With clarity of experience,  Scan-Optics has consistently
demonstrated  the  ability  to  maximize  system   performance   while  limiting
investment  requirements  for its clients.  By extending this  capability to the
Application  Service Provider (ASP)  environment we now provide our clients with
the option to receive cost reduction and service  benefits  through an ASP model
as well as through our traditional in-house solution.

The  Company's  strategy is to expand into the larger  market  opportunities  in
Business Process Outsourcing (BPO) while utilizing the primary core competencies
of the Company in vertical solution applications.

The Company is applying its resources to provide customer solutions in four main
areas: SO series image scanner platform and solution applications,  the Test and
Assessment Market, Business Process Outsourcing and Access Services. The Company
has  established  these  divisions  to  focus  the  Company's   resources  in  a
cost-effective  manner on the clients that it serves.  Although each activity is
autonomous  in  pursuit  of new  business  and  revenue  sources,  they  possess
tremendous   synergy  for  the  end-user  community  that  is  searching  for  a
"single-source" supplier.

The Company's SO series scanner  platform and solutions  continues the Company's
36 year  commitment to the very high end of the image capture  market.  Like its
predecessor,  the 9000 series scanner,  this SO series scanner family integrates
technology  based on years of  experience  and expertise in the  development  of
cost-effective,  high quality  solutions  for  applications  in the  government,
insurance, assessment,  transportation, order fulfillment and financial markets.
Unlike  its  predecessor  the SO series  scanner  opens  significant  new market
opportunities  in the  "image  only"  world.  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.

In the Assessment market, the Company follows an ISO9001:2000 documented quality
process to define the customer  requirements  prior to  proposing a  value-based





                                       3
<PAGE>

information  capture solution.  The solution may be rich in Scan-Optics  product
and technology content or may integrate third-party  technology to meet specific
customer  objectives.  The  company has  continually  invested in the skills and
expertise  within  its  development  organization.   Therefore,  Scan-Optics  is
positioned to deliver quality solutions to this market in a timely manner.

The  Business  Process  Outsourcing  (BPO)  service is focused in four areas (1)
document  conversion  services,  (2) data  capture,  (3)  business  continuation
services and (4)  knowledge  applications.  These  services  provide a low-risk,
cost-effective  solution for  customers  with  document  imaging  needs and will
follow the  disciplined  ISO9001:2000  processes  for quality  control that have
served the division in the past.

The Access Services Division of the Company provides third party and proprietary
product maintenance services nationwide, as well as in the UK and Canada. Access
Services has been selected by over 28 companies to provide maintenance  services
for their  products  at  customer  sites or through  the Access  Services  depot
maintenance facility. In support of its many third-party contracts,  the Company
has adapted its logistics and dispatch center to support these high volume,  low
cost products.  This business model  demonstrates the flexibility of the Company
to provide customized services to meet specific customer needs. Like the rest of
the Company,  this division  depends on its  ISO9001:2000  quality  processes to
assure high levels of customer satisfaction.


Target Markets
Scan-Optics' key values to the markets it serves are its customer  relationships
and  commitment  to  customer  satisfaction,  expertise  in  data  entry,  forms
processing,  OCR/ICR/OMR  and archive,  storage and retrieval  solutions and its
experience in systems integration. Scan-Optics' focus on communicating these key
values - Customer Satisfaction, Relationships, Quality, Experience and Expertise
is an integral factor in all of its marketing activities.

The Company's target markets for 2005 include its existing customer base and the
vertical  markets they  represent,  the Federal  Government and the  value-added
Reseller/Channel market.

Scan-Optics Technology
The  Company  has been a leader of  technological  developments  in the  Optical
Character  Recognition (OCR),  Intelligent  Character Recognition (ICR), Optical
Mark Read (OMR) and Imaging arena. Our most recent  developments  yielded patent
applications  for  gray  scale  OMR  recognition  for  assessment  applications,
software based  endorsement of images, a patent for "detecting double documents"
using acoustic sensors and a high performance  image scanner based on a software
design residing on Intel platforms in a Microsoft environment.

Software Products
Scan-Optics'  AccuScore,  for the  automatic  scoring of  "bubble"  forms,  uses
electronic  image-capture  technology in  conjunction  with patent  pending gray
scale OMR  recognition  software for  performing the scoring with:

o Inexpensive paper or printing




                                       4
<PAGE>

o Industry standard image scanners
o Flexible, easy-to-use forms definition tool
o Extremely high accuracy rates
o Greater flexibility in forms design

Scan-Optics'  DocWise,  provides a secure digital  information archive utilizing
sophisticated  workflow  processes.  DocWise  can  store  virtually  any type of
electronic file: E-mail,  computer documents (Microsoft Excel and Word), digital
photos,  faxes,  XML files and ERM  reports.  DocWise  provides  security  under
Windows NT, 2000 and XP security architecture with seven levels of access rights
built in.  DocWise is  designed  to work with the  Microsoft  suite of  database
products and Oracle's 8i Database  product.  DocWise has both an Internet client
and a desktop client for optimum flexibility. DocWise has the capacity to import
and index thousands of documents per hour in industry standard TIFF format.


Scan-Optics'  VistaCapture is a software solution suite for rapid development of
data  capture  applications  requiring  character  recognition,   business  rule
oriented workflow and systems integration.

SONAR (Scan-Optics Neural Auxiliary  Recognition) is a software product released
in 2001. SONAR  incorporates the Company's patented Context Edit product and ICR
recognition   technology  for  lower  volume  forms/data  capture  applications.
Applications  such as  enrollments  with address  changes are ideally suited for
SONAR.

Core Competencies
Key product  disciplines  utilize  integration  expertise  and  experience  that
leverage  the core  competencies  of the  Company to provide  specific  solution
alternatives. These core competencies include:
      High  performance  production  level document  scanning
      Image enhancement algorithms to create high levels of image quality
      Character recognition (OCR, ICR, Barcode, Mark Sense, OMR, etc.)
      Key-From-Image and Key-From-Paper data entry
      Document management, workflow and availability
      Test and Assessment domain knowledge
      Professional Services (design, development, installation and support)
      Value Added Engineering services and solutions
      ISO9001:2000 documented process controls in all business disciplines




                                       5
<PAGE>


Professional Services
In order to provide a  solution  that meets the  processing  requirement  of the
client the Company provides a consultative  approach to integrate solutions with
proven professional services core competencies in the following areas:

  Application Expertise      Industry Standards        Open Systems
  Archival / Retrieval       Installation              Paper Handling
  Custom Engineering         Microfilming              Project Management
  Development Tools          Networking                Systems Engineering
  Forms Design               Neural Technology         System Integration
  Imaging                    OCR Technology            Training
  Microsoft 2000             Database                  Performance Tuning

The  Company  has  provided  software  solutions  to its  customers  since 1968.
Utilizing  Company  developed  products  as well as  third-party  products,  the
professional services group provides solutions to address the customer's mission
critical  applications.  The  Company's  image  scanners  provide  the  hardware
platforms for delivering  advanced  high-volume forms processing,  imaging,  and
document  management system solutions,  especially in its target markets.  These
targeted  solutions  are designed and  developed  by  professional  services and
implemented  on the  customer's  site or in the  Scan-Optics  BPO facility.  The
Company also provides  ongoing change control with  individual,  custom software
services as  requested  by the client.  In this way, the Company can provide the
entire  solution of hardware  and  software  with  support for the length of the
contract.

Customer Satisfaction
Customer  satisfaction  continues to be a key area of focus for the Company. Our
quality  processes focus on the delivery of quality products and services and we
monitor,  measure and internally report customer  satisfaction levels in various
surveys  conducted  throughout  the year.  The surveys  also follow a documented
quality process within our ISO9001:2000 certification program.

ACCESS SERVICES DIVISION

The Company has offered  service and  maintenance  support to its customer  base
since 1968.  This support,  offered  through our Access  Services  Division,  is
available  with  either  leased  or  purchased  systems  in  both  domestic  and
international  markets.  In addition to supporting Company products,  the Access
Services  Division  provides  service  and  maintenance  support on a variety of
electro-mechanical  products  for more than 28  different  domestic  and foreign
manufacturers.

Maintenance  service is  provided  through a network of over 120 highly  skilled
service technicians,  including employees and contractors.  The Company provides
on-site  service with response  times of 2 to 24 hours based on the service plan
selected by the customer.  In support of its third-party  maintenance  contracts
Access Services has developed  comprehensive  depot maintenance  capability with
logistics  and  call  center  support.  The  Company  focuses  on  comprehensive





                                       6
<PAGE>

diagnostic  routines,  modular designs,  preventive  maintenance  procedures and
customer  surveys  to  provide  its users high  system  availability  to perform
mission critical applications.

BUSINESS PROCESS OUTSOURCING

Beginning with the customer's  needs, the Company can implement each outsourcing
engagement/project  from concept through production.  The capabilities  provided
include:
         Project Management
         Networks/System Integration
         Systems Testing
         Professional Services and Training

Scan-Optics has successfully  utilized its manufacturing  process disciplines in
structuring an outsourcing service capability for image capture,  data entry and
knowledge management. The Company has gained significant experience,  validating
management's  belief  that  significant  customer  value is achieved in terms of
quality and efficiency when managing the BPO workflow under  documented  process
and workflow controls.

SIGNIFICANT CUSTOMERS

In 2004 the Company  derived 11% of its total revenue from one customer Mitsui &
Co Ltd.,  one of the  Company's  distributors  in Japan.  In 2003,  the  Company
derived 23% of its total revenue from one customer, Northrop Grumman, IT Inc. In
2002 no customers accounted for more than 10% of total revenue.

CHANNELS OF DISTRIBUTION

The Company sells to end-users,  system  integrators,  value added resellers and
independent distributors in both the domestic and international markets.

QUALITY

All aspects of the Company's business fall under the ISO9001:2000  certification
requirements.  Customer satisfaction is a driving priority and the chosen method
of producing the measurable results is through the documented procedures defined
in the Company's quality manual.

BACKLOG

The backlog for the Company's  products and services as of December 31, 2004 was
approximately   $13.1  million.  As  of  December  31,  2003,  the  backlog  was
approximately  $15.2  million.  Backlog as of March 11,  2005 was  approximately
$14.8 million.  The backlog consists of firm orders for equipment,  software and
services,  the majority of which are expected to be delivered within the next 12
months, and maintenance due on existing contracts expected to be provided during
the next 12 months. The Company normally delivers a system within 30 to 180 days
after receiving an order, depending upon the degree of professional services and
software customization required.



                                       7
<PAGE>



COMPETITION

The SO series  scanner  competes  with the high end of the Kodak product line as
well as other companies that serve niche markets.  Our strategy is to compete in
this $140M market based on price and performance.

In the  assessment  market we compete with a "solution"  focus that includes the
integration  of  technologies  that yield a product  uniquely  designed  for the
testing environment defined by the client. Our competition is typically in-house
development,  which  would  cause  us  to  modify  our  approach  to  enter  the
opportunity with a technological  component as a  sub-contractor.  Due to the No
Child Left Behind Law this is  currently a very active  market where we are well
positioned.

Business Process Outsourcing is a $13 billion market and the competition is well
established,  however the expertise and experience at  Scan-Optics  allows us to
provide a defined  lower  cost  benefit  for the  client.  Our  client  base has
required improved efficiencies over the years that we have supplied. Our clients
have generally  received long term benefits based on short "payback"  periods of
18 months to 2 years, which we can make our advantage as we market the solutions
based on transaction based pricing versus integrated systems pricing.

Over 50% of the revenue  generated  by the Access  Services  Division is derived
from post installation hardware and software services on Scan-Optics  integrated
systems.  Due to the  proprietary  nature  of  these  integrated  systems,  this
division  faces  little  competition  for this  business.  The  majority  of the
remaining revenue is generated by the field repair of electro-mechanical devices
manufactured  by  third-party  equipment  manufacturers,  primarily  of  scanner
products,  that do not have  there own field  maintenance  staff.  The  division
competes with other third party maintenance  providers for this revenue by using
its reputation for quality,  which has been generated from the strict  adherence
to its  ISO9001:2000  quality  process  manual and its 35 years of experience in
providing scanner repair.


ISO9001 CERTIFICATION

In 2000,  the Company  took the first step in expanding  its quality  program by
bringing the Access Service Division into compliance with the already  certified
product development  organization and manufacturing  division.  The Company also
performed  internal  audits  to  test  for  compliance  in  the  sales,  design,
manufacturing  and service  areas to continue to improve the quality  management
system. The registering body performed four surveillance audits on the Company's
product development and manufacturing divisions, all of which were successful.

In 2001, the Company maintained its quality systems and began to prepare for the
transition to ISO9001:2000.

During  November  2002,  the Company  introduced  the new quality  scope,  which
encompasses all areas of the Company.  The scope of the certification is for the
design,  manufacture,  installation  and  service  of  scanning  equipment;  the
contract manufacturing,  installation and service of electro-mechanical devices;





                                       8
<PAGE>

the provision of related  products and software  services  including the design,
development,  installation  and support;  and project  management  of integrated
solutions for targeted lines of business.

In 2003, we completed our transition to ISO9001:2000 and obtained  certification
in  May  2003.  We  initially   targeted  October  2003  to  complete  our  2000
certification,  but through teamwork and corporate  commitment  enterprise-wide,
Scan-Optics achieved certification five months earlier than the target date.

In 2004,  we  continued  to monitor  and  maintain  our Quality  System  through
internal audits,  corrective and preventive  actions and continuous  improvement
initiatives.  Our next third party  surveillance  audit is  scheduled  for April
2005.


PATENTS

The Company  currently  has nine United  States  patents in force,  which expire
between 2005 and 2022,  and two patents  pending.  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 attempts 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 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 Company filed
for a patent for gray scale OMR used in test scoring applications.  In 2001, the
Company received the patent for the ultrasonic  overlapping  document  detection
system for our scanners.


EMPLOYEES

As of December  31,  2004 the Company  employed  183 people,  including  16 with
administrative  responsibilities,  12 in marketing and sales, 98 in software and
service  activities,  9 in engineering and 48 in manufacturing  capacities.  The
Company  considers  its  employee  relations  to be good.  The  Company  has not
experienced any work stoppages.


FUNDED DEVELOPMENT AGREEMENTS

During  2004,  2003 and 2002,  the Company  completed  a number of small  custom
development   contracts   for  specific   customers   resulting  in  revenue  of
approximately $79,000, $200,000 and $43,000, respectively. These revenues offset
the related costs incurred for this development. The Company owns the technology
developed under these contracts. No royalties or other consideration is required
as part of these agreements.




                                       9
<PAGE>



EFFECTS OF ENVIRONMENTAL LAWS

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


BUSINESS SEGMENTS

The Company views its business in three distinct operating  segments:  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)                                   2004                      2003                     2002
---------------------------------------------------------------------------------------------------------
<S>                                       <C>                   <C>                       <C>
Revenues
  Solutions and products                  $    15,886           $        21,108           $      16,376
  Access services                              10,933                    10,563                  11,499
  Contract manufacturing services               1,922                       410                   1,466
                                          ---------------------------------------------------------------
    Total revenues                             28,741                    32,081                  29,341

Cost of solutions and products                 12,528                    13,407                  10,715
Service expenses                                8,980                     8,813                   8,539
                                          ---------------------------------------------------------------

    Gross profit margin                         7,233                     9,861                  10,087

  Operating expenses, net                      10,931                     9,017                   9,064
                                          ---------------------------------------------------------------
Income (loss) before income taxes         $    (3,698)          $           844           $       1,023
                                          ===============================================================
Total assets                              $    24,338           $        26,073           $      26,406
                                          ===============================================================
Total  expenditures  for  additions
to long-lived assets                      $       329           $           173           $          79
                                          ===============================================================
</TABLE>


The Solutions and Products  Division  includes the sale of hardware and software
products  as well as  professional  services.  Contract  Manufacturing  Services
provides  assembly and test services under  contracts with customers who develop
and sell a variety of equipment.

The Company has international  distributors located in 13 countries and covering
six continents. All international sales other than sales originating from the UK
and Canadian  subsidiaries are denominated in United States dollars.  Changes in
the economic  climates of foreign  markets could have an  unfavorable  impact on
future international sales.



                                       10
<PAGE>

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

<TABLE>
<CAPTION>
(thousands)             2004                      2003                         2002
-----------------------------------------------------------------------------------------------
<S>              <C>            <C>       <C>              <C>         <C>             <C>
Latin America    $        82    2 %       $        124     12 %        $         72    24 %
Europe                   161    5                           0                   149    49
Pacific Rim            3,302   93                  944     88                    81    27
                -------------------------------------------------------------------------------
                 $     3,545  100 %       $      1,068    100 %        $        302   100 %
                ===============================================================================
</TABLE>

Export sales  represented  22%, 5%, and 2% of the Solutions and Products Segment
revenues  for  the  three  years  ended  December  31,  2004,  2003,  and  2002,
respectively.  There are no exports  sales  derived  from the  Company's  Access
Services Segment or Contract Manufacturing Services Segment.


ITEM 2 - PROPERTIES

The Company's world  headquarters  and  manufacturing  facility is located in an
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  2005,  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

As of December  31,  2004,  the Company had settled all  outstanding  claims and
contingencies  pending during 2004 with no  significant  effect on cash flows or
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 2004 to a
vote of the stockholders.



                                       11
<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 on the Over-the-Counter  Bulletin Board based upon
information provided by the National Association of Securities Dealers, Inc. The
closing  quotations  represent  prices between dealers and do not include retail
markups,  markdowns or commissions  and may not represent  actual  transactions.
There were 901 stockholders of record at December 31, 2004.


<TABLE>
<CAPTION>
Quarter Ended          March 31                  June 30                 September 30               December 31
                  High         Low          High          Low         High         Low          High        Low
-----------------------------------------------------------------------------------------------------------------
<C>              <C>          <C>          <C>          <C>           <C>         <C>          <C>        <C>
2004             $  .80       $  .46       $  .70       $  .28        $  .43      $  .22       $  .30     $  .18
2003             $  .35       $  .25       $  .65       $  .27        $  .74      $  .50       $  .70     $  .45
</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  Company's  loan  agreement  does not  allow  dividend
payments on common stock.


See "Item 12 - Security  Ownership of Certain  Beneficial  Owners and Management
and Related  Stockholder  Matters" for  information  about the Company's  equity
compensation plans.


On August 6, 2004, the Company  issued an aggregate of 34,425,345  shares of its
common stock, $.02 par value (the "Shares") to lenders affiliated with Patriarch
Partners, LLC (the Lenders), in a recapitalization  pursuant to a Second Amended
and Restated  Subscription  and Repurchase  Agreement dated as of August 6, 2004
between the Company and the Lenders.  The issuance of Shares to the Lenders is a
key component of a comprehensive  financial  restructuring  arrangement with the
Lenders  commenced as of March 30, 2004 pursuant to the terms of a Third Amended
and Restated Credit Agreement between the Company and the Lenders.  The terms of
the purchase and sale are discussed under "Management's  Discussion and Analysis
of  Consolidated  Financial  Condition  and Results of Operation - Liquidity and
Capital  Resources."  The  transaction  was made pursuant to the exemption  from
registration in Section 4(2) of the Securities Act of 1933, as amended.




                                       12
<PAGE>




ITEM 6 - SELECTED FINANCIAL DATA

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

<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA

(thousands, except share data)                       2004           2003            2002           2001             2000
---------------------------------------------------------- --------------- --------------- ---------------- ---------------
<S>                                       <C>              <C>             <C>             <C>              <C>
Total Revenues                            $       28,741   $       32,081  $      29,341   $      30,740    $     38,302
                                          ================ =============== =============== ================ ===============

Income (loss) before income taxes                (3,698)              844          1,023          (6,280)        (17,709)

Income taxes (benefit)                               71             (142)             81              33              61
                                          ---------------- --------------- --------------- ---------------- ---------------

Net Income (Loss)                         $      (3,769)   $          986  $         942   $      (6,313)   $    (17,770)
                                          ================ =============== =============== ================ ===============

Basic earnings (loss) per share           $        (.18)   $          .14  $         .13   $        (.90)   $      (2.53)
                                          ================ =============== =============== ================ ===============

Basic weighted-average shares                 20,890,686        7,026,232      7,026,232       7,026,232       7,025,064
                                          ================ =============== =============== ================ ===============

Diluted earnings (loss) per share         $        (.18)   $          .13  $         .13   $        (.90)   $      (2.53)
                                          ================ =============== =============== ================ ===============

Diluted weighted-average shares               20,890,686        7,806,491      7,317,437       7,026,232       7,025,064
                                          ================ =============== =============== ================ ===============

SELECTED BALANCE SHEET DATA
Total assets                              $       24,338   $       26,073  $      26,406   $      27,380    $     36,513
Working capital (deficit)                          2,912            4,957          5,394           4,184          (9,833)
Long term obligations                             11,142            9,379         10,428          11,397
Mandatory redeemable preferred stock                 855            4,286          4,054           3,800
Total stockholder's equity                         2,314            2,443          1,383             360           4,307
</TABLE>


The Company has not paid any dividends for the five-year  period ended  December
31, 2004.

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

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






                                       13
<PAGE>




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

Forward Looking Information
Certain  statements  contained  in this  Annual  Report on Form 10-K may contain
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the  Securities  and  Exchange Act of 1934 and as
such may involve known or unknown risks,  uncertainties  and other factors which
may cause the  Company's  actual  results,  performance  or  achievements  to be
materially different from future results,  performance or achievements expressed
or implied by such forward-looking statements. Forward-looking statements, which
are based on certain  assumptions  and  describe  the  Company's  future  plans,
strategies  and  expectations  are  generally  identifiable  by use of the words
"may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend"
or "project" or the negative thereof or other  variations  thereon or comparable
terminology.  Factors  which  could  have  a  material  adverse  effect  on  the
operations and future prospects of the Company  include,  but are not limited to
those set forth below.  These risks and  uncertainties  should be  considered in
evaluating any forward-looking statements contained or incorporated by reference
herein.

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.  Although the Company  completed a debt
restructuring  effective March 30, 2004 (see  "Liquidity and Capital  Resources"
for further  information),  the Company  remains  highly  leveraged and could be
adversely  affected by a significant  increase in interest  rates. A one percent
increase  in the prime  rate would  increase  the  annual  interest  cost on the
outstanding loan balance at December 31, 2004 of approximately  $11.6 million by
$.1 million.  The Company  completed a  recapitalization  on August 6, 2004 (see
"-Liquidity  and Capital  Resources"  and Note F to the  Company's  Consolidated
Financial Statements for further details), and as a result the Company's lenders
have acquired a significant  voting control and  accordingly  have the right and
the ability to influence the way in which the Company does  business,  including
its strategy and tactics.  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 and
services may be replaced by  alternative  technologies.  Further,  the Company's
business could be adversely affected by technological changes.

Overview
The Company  reported  net loss for the year of $3.8  million or $.18 per share,
compared to a net income of $1 million, or $.13 per diluted share, for 2003. The
Company's ability to effectively  address these issues will have a direct impact
on its  operating  results,  its  ability to  generate  sufficient  cash to fund
operations and its ability to comply with existing debt covenants. The Company's
operating  results for 2004 were  significantly  adversely  affected compared to
2003 by certain non-recurring and transitional events,  including the settlement
of outstanding  litigation,  the phasing out of the sale of the Company's mature
line of 9000 Series scanners, the phased market introduction of varied models of
the Company's new generation of SO Series  scanners,  and the development of new
channels of distribution  for the Company's  hardware and software.  During 2004
the Company executed a financial  restructuring  and  recapitalization  that was
approved at the annual  meeting on July 15,  2004.  See  "Liquidity  and Capital
Resources" and Note F to the Company's  Consolidated  financial statements under





                                       14
<PAGE>

Item 8 of this Form 10-K.  The Company  continued its investment in research and
development  for a new image scanning  platform in 2004 and introduced the first
product in the SO series family during the AIIM trade show in March 2004. The SO
product  earned "Best in Show Award" for high-end image  scanners.  This success
was  followed  by the  installation  of the  in-line  OCR  version in the fourth
quarter  of 2004.  This  image  scanner  family  was  designed  to  satisfy  the
requirement  of our very  sophisticated  customer  base but is also  scalable to
provide excellent price performance in the competitive market space.

The Company has three major initiatives currently underway to develop sources of
revenue  growth and  profitability.  The first is to capitalize on the SO series
investment and generate significant sales revenues in the high-end image scanner
market both domestically and internationally. In 2004 the Company introduced its
entry into the Business Process  Outsourcing  marketplace with initial contracts
in state tax  processing,  warranty  registration  forms  processing,  knowledge
management and business  continuation  services.  The Company is also focused on
the assessment market with "solution" content.  Currently on hold is activity to
add long term  value  through  the  acquisition  of key  strategic  services  or
enterprises.  The inability of the Company to carry out these  initiatives could
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 its  high-speed  image  transports.  The  Company has
expanded  its target  market  approach  to  include  value-added  resellers  and
distributors.  It has also expanded its market coverage to include International
distributors in Japan and other countries.

The second  initiative is Business  Process  Outsourcing  ("BPO")  Services that
offer the market access to the Company's technology and systems on a transaction
basis. The Company's' BPO Services provide a low-risk,  cost-effective  solution
for customers  with  requirements  for document  conversion  services,  business
continuation services, knowledge management or business process outsourcing. The
BPO services offer  customers a high quality,  ISO9001 2000  certified,  turnkey
outsourcing  solution utilizing the Company's  proprietary  hardware technology,
and further leveraging software skills, resources and process controls.

The third initiative is the solution focus in the assessment  market.  Fueled by
the No Child Left Behind law, Scan-Optics has experienced significant success in
this market adding significant value with our proprietary software solutions and
high performance image and optical mark read (OMR) scanners.

The Access Services Division continues to provide critical support capability to
customers as well as other third  parties where they provide  services.  Through
the division's 120 technical service  representatives,  including  employees and
contractors,  strategically located throughout the US, the Company believes that
it can provide high quality, cost effective maintenance to its existing customer
base as well as new accounts.

While the Company is principally focused on achieving  consistent  profitability
with its existing  operations,  the Company may consider acquiring key strategic
products  or  enterprises.  Acquisitions  will be  considered  based  upon their
individual merit and benefit to the Company.




                                       15
<PAGE>



RESULTS OF OPERATIONS - 2004 VS. 2003

Total revenues decreased $3.3 million or 10% from 2003 to 2004.

Hardware and software revenue decreased $4.2 million or 26% from the prior year.
North American sales  decreased $3.2 million or 28%. Total  international  sales
increased  to  $3.5   million  in  2004   compared  to  $1.1  million  in  2003.
International  sales  in the  Pacific  Rim  increased  to  $3.3  million  due to
significant  scanner  systems  orders  and  spare  parts  sold to the  Company's
distributor  in Japan.  Sales to  Europe  and Latin  American  increased  to $.2
million in 2004  compared  to $.1  million in the prior  year.  The  Company has
phased out the sale and  production of its mature line of 9000 Series  scanners,
while introducing to the market,  in phases,  varied models of the Company's new
generation of SO Series scanners and developing new channels of distribution for
the Company's hardware and software, which concurrent activities accounted for a
majority of the decreased hardware and software revenue.

Professional  services revenue increased to $5.9 million ($.5 million or 8% from
2003 to 2004)  mainly  due  increased  solution  sales to the  Company's  target
customer base.

Access services revenue  increased to $10.9 million ($.4 million or 4% from 2003
to 2004).  Commencing in the fourth quarter of 2004,  revenues on contracts that
are not expected to be activated are  recognized  over the estimated  final term
for which the Company may possibly be required to perform.  Under this change in
accounting  estimate,  the Company  recognized $.4 million revenues on contracts
for which its obligation to perform is remote.  Other  increases in revenue from
the  Company's  third  party  maintenance  business  were offset by a decline in
proprietary maintenance contracts.

Cost of hardware and software  revenue gross margin for 2004 was 19% compared to
33% for 2003 and reflects the start up phase of the new SO Series scanners.  The
gross  margin in 2004  included  a  provision  of $.5  million  for  slow-moving
inventory.

Cost of professional  services revenue gross margin in 2004 was 52%, as compared
to 50% in 2003.  The  change  was mainly due to  increased  sales  volume  which
results in higher utilization rates for available resources.

Cost of Access services  revenue gross margin was 18% in 2004 compared to 17% in
2003 reflecting higher sales volume and a relatively fixed cost structure. Gross
margin in 2004 was effected by a $.3 million provision for slow-moving inventory
related to the United Kingdom.

Sales and marketing expenses decreased $.1 million or 4% from 2003,  principally
due to lower  salary  and  commission  expenses  partially  offset by  increased
advertising expense.

Research and development  expenses increased $.7 million or 54% from 2003 mainly
due to higher  salary and external  consulting  costs in 2004.  These costs were
lower in 2003 due to the capitalization of certain software development costs.

General and administrative  expense increased $1.2 million or 34% from 2003. The
increase reflects a $.5 million provision for accounts receivable as a result of
the  settlement  of a legal  action.  The  remaining  portion of the increase is



                                       16
<PAGE>

mainly due to increased  legal fees of $.2 million,  stock option expense of $.2
million, health insurance claims expense of $.2 million and other expenses.

Interest  expense of $.9 million  remained  consistent  with 2003.  The weighted
average interest rate was 7.3% in 2004 compared to 4.8% in 2003. The increase in
the weighted  average interest rate is due to accretion on the $1.5 million term
loan  working  capital  facility  for which the Company is obligated to repay $2
million at maturity.

Other income decreased $.1 million from 2003. In 2003, the Company recognized as
other income on $.1 million for  previously  recorded  liabilities  that were no
longer due or had been settled for amounts less than that previously recorded.

Income tax expense  increased  $.2 million from 2003 mainly for state income and
foreign taxes.



RESULTS OF OPERATIONS - 2003 VS. 2002

The 2002  consolidated  financial  statements  have been  restated  to reflect a
change in the application of generally accepted  accounting  principles relating
to the  adjustment  of  certain  liabilities.  The  Company  identified  certain
liabilities  relating to services and transactions dating back to 2002 and 2001.
In 2003, the Company  determined the amounts were no longer valid obligations of
the  Company.  Further,  it was  determined  that payment of the  obligation  or
resolution of the circumstances  originally  creating the liability  occurred in
2002. As a result,  the liabilities  should have been removed from the Company's
books in 2002.  The net  impact of this  change  increased  2002 net  income and
earnings per share by $111,000 and $.02, respectively,  representing a reduction
of payables offset by required  additional  bonuses.  The effect of income taxes
was determined immaterial.

Total revenues increased $2.7 million or 9% from 2002 to 2003.

Hardware and software revenue increased $4.8 million or 42% from the prior year.
North American sales increased $4.2 million or 38% due mainly to the replacement
or upgrade of  existing  Series  9000  systems at current  customer  sites.  The
Company does not expect the replacement revenue to continue at the same level as
2003.  Total  international  sales  increased  $.6  million  or 189% from  2002.
International  sales in the  Pacific  Rim  increased  849% or $.7 million due to
spare parts orders and a scanner  system sold to the  Company's  distributor  in
Japan.  Sales to Europe and Latin American  decreased $.1 million from the prior
year.

Professional  services  revenue  decreased $1.1 million or 16% from 2002 to 2003
mainly due to the decrease in the service revenue  component of certain hardware
systems installations and difficulties in the current U.S. economy.

Access services revenue decreased $.9 million or 8% from 2002 to 2003 due mainly
to a decrease in revenue from the Company's proprietary maintenance contracts as
a result of lower maintenance rates for the latest generation of the Series 9000
scanner,  the 9000M, as compared to the earlier Series 9000 scanner. The Company
was also impacted by a few customers discontinuing maintenance due to changes in
their business or the use of other technologies.




                                       17
<PAGE>

Cost of hardware and software  revenue  increased $2.9 million or 37% from 2002.
The increase in cost is mainly due to an increase in hardware and software sales
volume. In 2003, the Company recorded  approximately  twice the number of Series
9000 scanners  sales as compared to 2002,  which  accounted for more revenue and
therefore increased  manufacturing  costs. Cost of hardware and software revenue
as a percentage of revenue was 67% in 2003, as compared to 69% in 2002.

Cost of  professional  services  revenue  decreased  $.2  million  or 6% in 2003
compared  to the prior  year  mainly due to  decreases  in  salaries  and travel
expenses.  Cost of professional  services revenue as a percentage of revenue was
50% in 2003,  as  compared  to 44% in  2002,  due  mainly  to a  decline  in new
solutions sales, as well as fixed costs that exist to support a higher volume of
business.

Cost of Access services  revenue  increased $.3 million or 3% from 2002 to 2003.
The increase is principally due to an increase in UK operating expenses. Cost of
Access services  revenue as a percentage of revenue was 83% in 2003, as compared
to 74% in 2002,  traceable to lower revenues in 2003 and a relatively fixed cost
structure.

Sales and marketing expenses increased $.2 million or 6% from 2002,  principally
due to an increased use of outside services related to the Company's new website
as well as increases in consulting  services related to an effort to expand into
the federal government market, and increased trade show activity.

Research and development  expenses decreased $.5 million or 30% from 2002 mainly
due to the capitalization of certain software development costs.

General and administrative  expenses remained  consistent with the prior year. A
reduction in legal  expenses of $.2 million and $.1 million of bad debt recovery
was offset by  increased  salary  expense of $.2  million  and  increased  group
insurance expense of $.1 million.

Interest  expense of $.8 million  remained  consistent  with 2002.  The weighted
average interest rate was 4.8% in 2003 compared to 5.5% in 2002.

Other income  decreased  $.3 million from 2002 mainly due to a reduction in 2002
of $.4 million for certain amounts previously  recorded as liabilities that were
no longer due or have been settled for amounts less than previously recorded.

Income tax benefit  increased  $.2 million from 2002 mainly due to the reduction
of potential tax exposures  associated  with certain state and foreign  exposure
items.






                                       18
<PAGE>



LIQUIDITY AND CAPITAL RESOURCES

Cash and cash  equivalents  at December 31, 2004 of $.5 million  decreased  $0.1
million from December 31, 2003.

Outstanding  borrowings  increased $3.6 million to $11.6 million at December 31,
2004 from $8.0 million at the end of 2003. The available  balance on the line of
credit was $1.5  million at December 31,  2004.  As of December  31,  2004,  the
Company is in compliance with all financial  covenants.  The Company anticipates
meeting  its current  obligations  and other  resource  needs in 2005 with funds
generated  through  operations  and  its  available  line  of  credit.  However,
Underachieved  operating results could adversely effect the Company's ability to
remain in compliance.

On August 6, 2004, the Company  completed a  recapitalization  with its lenders,
Patriarch  Partners LLC, (the Lenders) after obtaining  stockholder  approval at
the Company's July 15, 2004 annual meeting. The recapitalization included, among
other terms, the cancellation of $3.8 million of mandatorily redeemable Series B
preferred  stock,  including  accrued  dividends,  and warrants for 33.2% of the
Company's  outstanding  common stock on a fully-diluted  basis, both held by the
Lenders,  in exchange for the issuance of  34,425,345  shares of common stock of
the  Company  (or  79.8%  of  the  Company's   outstanding  common  stock  on  a
fully-diluted  basis, subject to dilution for certain compensatory stock options
granted by the Company) to the Lenders. In addition:

            * The Company's  secured term and revolving debt was exchanged for a
$9.0 million term loan and a $2.5 million  revolving  loan. The new term loan is
payable in annual  amounts of $90,000  beginning  April 1, 2005 with the balance
due at maturity. Borrowings accrue interest at a rate of prime plus 2%.

            * An additional $1.5 million term loan working capital  facility was
made available to the Company, with the Company obligated to repay $2 million at
maturity. (Interest is being accreted such that the carrying amount of this loan
at maturity will be $2 million.) This loan accrues interest at the prime rate.

            * The Company's financial covenants with respect to backlog, capital
expenditure and EBITDA were modified.

            * Effective  upon the closing of the  recapitalization  on August 6,
2004,  the maturity date for all of the Company's  secured  indebtedness  to the
Lenders was extended through March 30, 2007.

The Company  believes that the 2004 loan  restructuring  will allow execution of
the Company's business plan through the term of the credit agreement by reducing
required short-term  payments under the borrowing  arrangements with the Lenders
and increasing  available  funds through the working capital term loan facility,
thereby enhancing the Company's  ability to invest in its business,  by lowering
the  thresholds of the  financial  covenants  and by extending  loan  maturities
through March 2007.





                                       19
<PAGE>



The Company's  significant  contractual  obligations and commitments that impact
its liquidity as of December 31, 2004 follow:

<TABLE>
<CAPTION>
Contractual Obligations                                 Payments Due by Period
-----------------------------------------------------------------------------------------------------
                                                     Less
                                                    than 1          1 - 3       4 - 5       After 5
(thousands)                             Total        year           years       years        years
------------------------------------------------ ------------ ------------- ------------ ------------
<S>                               <C>            <C>          <C>           <C>          <C>
Notes payable                     $     11,605   $     1,000  $     10,605
Redeemable preferred stock                 855                         855
Executive insurance agreement              359            50           100  $       100  $       109
Capital leases                             225            84           141
Operating leases                         1,262           450           552          104          156
                                  -------------- ------------ ------------- ------------ ------------
Total contractual
     cash obligations             $     14,306   $     1,584  $     12,253  $       204  $       265
                                  ============== ============ ============= ============ ============
</TABLE>


Operating  activities  used $2.2  million of cash in 2004  compared to providing
$3.0 million in 2003.  Non-cash  expenses in 2004 were $4.2 million  compared to
$2.6 million in 2003. The non-cash items relate to depreciation, amortization of
customer service  inventory and software  license,  and provisions for losses on
accounts  receivable and slow-moving  inventory.  These and other  components of
operating activities are discussed below.

Net accounts  receivable  and unbilled  receivables  decreased $1.8 million from
December  31,  2003 due  principally  to lower sales in the second half of 2004,
$14.5  million,  as  compared  to the second  half of 2003,  $15.8  million  and
provision for losses on accounts receivable of $.6 million.

Total  inventories  increased  $.2  million  from  2003  levels.   Manufacturing
inventories  increased  $.8  million  during  the  year  due to an  increase  in
materials and component parts of $1.2 million and a decrease in  work-in-process
inventory of $.4 million.  Finished goods  inventory  remained  consistent  with
prior year levels.  The increase in materials and component  parts is mainly due
to the ongoing production schedule for the SO Series scanner in first quarter of
2005 as compared to the initial product launch schedule of the SO Series scanner
in early 2004. Customer service inventory decreased for the year by $.6 million,
which was mainly attributable to the amortization of spare parts.

Net plant and equipment  decreased $.1 million in 2004. This net decrease is due
to depreciation of $.4 million, partially offset by additions of $.3 million. No
significant additions are planned for 2005.

Accounts  payable  increased  $.5 million over December 31, 2003 relating to the
timing of payments.

Notes payable to bank  increased  $3.6 million as a result of borrowing  against
the Company's  available line of credit to fund increased  production  schedules
for the SO Series  scanner  and  general  corporate  needs.  Salaries  and wages
decreased  $.8 million from 2003 mainly due to the absence of a bonus accrual at
December 31, 2004.

Deferred revenue increased $.6 million as a result of the increase in annual and
quarterly maintenance billings that are subsequently  recognized in revenue over
the maintenance period covered by the billing.




                                       20
<PAGE>

Customer deposits  decreased $.8 million due mainly to large orders in 2003 that
contained deposit requirements as part of the contract which were not replicated
in the fourth quarter of 2004.

Other  current  liabilities  decreased  $.3  million due mainly to a $.3 million
decrease in various accrued  expenses.

Other long term  liabilities  decreased $.9 million mainly due to the conversion
of operating  leases  totaling $.8 million into  preferred  stock as part of the
debt restructuring effective August 6, 2004.











                                       21
<PAGE>


OTHER MATTERS

New Accounting Standards

Refer to Note B of the Notes to Consolidated  Financial Statements in Item 8 for
a discussion of new accounting  pronouncements  and the potential  impact on the
Company's consolidated financial statements.


Critical Accounting Policies

The policies  discussed  below are considered by management to be critical to an
understanding of the financial  statements  because their application places the
most significant  demands on management's  judgement,  with financial  reporting
results  relying on estimations  about the effect of matters that are inherently
uncertain.  Specific risks for these critical  accounting policies are described
in the following paragraphs.

Revenue recognition - proportional  performance:  The Company recognizes revenue
and  profit  on  professional   services   engagements  using  the  proportional
performance  method of  accounting,  which relies on estimates of total expected
contract  revenues and costs.  The Company follows this method since  reasonably
dependable  estimates of the revenue and costs applicable to various stages of a
contract can be made. Since the financial  reporting of these contracts  depends
on estimates,  which are assessed  continually  during the term of the contract,
recognized  revenues  and  profit  are  subject  to  revisions  as the  contract
progresses  to  completion.  Revisions in profit  estimates are reflected in the
period  in  which  the  facts  that  give  rise to the  revision  become  known.
Accordingly,   favorable  changes  in  estimates  result  in  additional  profit
recognition,  and  unfavorable  changes in  estimates  result in the reversal of
previously  recognized revenue and profits. When estimates indicate a loss under
a contract,  the  provision  for such loss is recorded in that  period.  As work
progresses  under a loss contract,  revenue  continues to be  recognized,  and a
portion of the contract costs incurred in each period is charged to the contract
loss reserve.  The estimated  loss is  calculated  and adjusted each period.  If
estimates change, the professional  services revenue,  cost of revenue and gross
margins will be impacted.

Allowance for doubtful  accounts:  The Company  evaluates the  collectability of
accounts  receivable  based on a  combination  of  factors.  In cases  where the
Company has knowledge of a specific  customer's  inability to meet its financial
obligations (e.g.,  bankruptcy filings,  substantial slow-down in recent payment
history) or contract disputes, a specific reserve for uncollectable amounts will
be  recorded.  For all other  customers,  the Company  records a reserve for bad
debts based on the age of the receivable balance. If circumstances change (i.e.,
higher  than  expected  defaults,   unexpected  material  adverse  change  in  a
significant  customer's ability to meet its financial obligations to the Company
or contract  disputes),  estimates of the collectability of amounts due could be
reduced by a material amount.

Inventories - slow-moving and obsolete: The Company performs regular reviews for
excess and obsolete  manufacturing  inventories  to  determine if the  inventory
valuation  allowances  are adequate to cover the value of parts deemed excess or
obsolete.  The review is based upon current inventory  levels,  expected product
sales  over  the  next  twelve  to  twenty  four  months  and  Access   Services
requirements  for spare parts.  Should the Company not achieve  expected product
sales or if Access Services parts requirements should change,  future losses may
occur through the  requirement  of  additional  reserves for excess and obsolete
inventory.  The spare  parts are  amortized  over  four  years and the  carrying
amounts are reviewed periodically for appropriateness.


                                       22
<PAGE>




Long-lived  assets:  The Company records  impairment losses on long-lived assets
(including  goodwill) 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 long-lived  assets,  to determine whether
events or  circumstances  warrant  revised  estimates  of useful  lives.  If the
business  plan's   operating   results,   the  Company  used  to  calculate  the
undiscounted  cash flows are not achieved,  a potential  impairment could result
with a write-down of the carrying value of long-lived assets required.







                                       23
<PAGE>



ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

On March 30,  2004,  the  Company  completed  a total  debt  restructuring  (see
"Liquidity and Capital Resources" for further information); however, the Company
remains  highly  leveraged  and could be  adversely  affected  by a  significant
increase  in  interest  rates.  A one  percent  increase in the prime rate would
increase the annual  interest cost on the  outstanding  loan balance at December
31, 2004 of approximately $11.6 million by $.1 million.

The Company has minimal foreign  currency  translation  risk. All  international
sales other than sales  originating  from the UK and Canadian  subsidiaries  are
denominated in United States dollars.

Refer to the  Overview  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.







                                       24
<PAGE>







              ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA









                                       25
<PAGE>



        REPORT of UHY LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




Stockholders and Board of Directors
Scan-Optics, Inc.


We have audited the accompanying consolidated balance sheet of Scan-Optics, Inc.
and subsidiaries as of December 31, 2004 and the related consolidated statements
of operations, stockholders' equity, and cash flows for the year then ended. Our
audit also  included  the  financial  statement  schedule for 2004 listed in the
Index  at  Item  15(a).   These  financial   statements  and  schedule  are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements and schedule based on our audit.


We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audit  provides  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, 2004 and the  consolidated
results  of their  operations  and their  cash  flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.  Also, in our opinion,  the related  financial  statement  schedule for
2004, when considered in relation to the basic financial  statements  taken as a
whole,  presents  fairly in all  material  respects  the  information  set forth
therein.

/s/ UHY LLP

Hartford, Connecticut
March 18, 2005








                                       26
<PAGE>



   REPORT of ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




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,  2003 and the related  consolidated
statements of operations,  stockholders'  equity, and cash flows for each of the
two years in the period ended  December 31, 2003.  Our audits also  included the
financial  statement  schedule  for 2003 and 2002  listed  in the  Index at Item
15(a).  These financial  statements and schedule are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements and schedule based on our audits.


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


In our opinion, the 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, 2003, and the  consolidated
results  of their  operations  and their cash flows for each of the two years in
the period ended  December 31, 2003, in conformity  with  accounting  principles
generally  accepted in the United  States.  Also,  in our  opinion,  the related
financial  statement  schedule  for the years ended  December 31, 2003 and 2002,
when considered in relation to the basic financial  statements taken as a whole,
presents fairly in all material respects the information set forth therein.


/s/ Ernst & Young LLP


Hartford, Connecticut
March 26, 2004





                                       27
<PAGE>



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

<TABLE>
<CAPTION>
                                                                           December 31
(thousands, except share data)                                    2004                      2003
-------------------------------------------------------------------------------------------------
<S>                                                         <C>                      <C>
Assets
Current Assets:
  Cash and cash equivalents                                 $      477               $       585
  Accounts receivable less allowance of $238 in 2004
         and $1,134 in 2003                                      4,314                     6,043
  Unbilled receivables - contracts in progress                     298                       415
  Inventories                                                    7,461                     7,282
  Prepaid expenses and other                                       389                       597
                                                           --------------------------------------
    Total current assets                                        12,939                    14,922


Equipment and Leasehold Improvements:
  Equipment                                                      3,386                     3,682
  Leasehold improvements                                         4,089                     4,010
  Office furniture and fixtures                                    557                       745
                                                           --------------------------------------
                                                                 8,032                     8,437
  Less accumulated  depreciation and amortization                7,095                     7,422
                                                           --------------------------------------
                                                                   937                     1,015



Goodwill                                                         9,040                     9,040
Other assets                                                     1,422                     1,096
                                                           --------------------------------------

Total Assets                                                $   24,338               $    26,073
                                                           ======================================
</TABLE>









                                       28
<PAGE>






<TABLE>
<CAPTION>
                                                                                            December 31
(thousands, except share data)                                                         2004               2003
-----------------------------------------------------------------------------------------------------------------
<S>                                                                            <C>                 <C>
Liabilities and Stockholders' Equity
Current liabilities:
  Accounts payable                                                             $      2,822        $      2,323
  Note payable                                                                        1,000
  Salaries and wages                                                                    702               1,484
  Taxes other than income taxes                                                         641                 758
  Income taxes                                                                           68                 189
  Deferred revenue                                                                    3,408               2,787
  Customer deposits                                                                     143                 929
  Other                                                                               1,243               1,495
                                                                             ------------------------------------
    Total current liabilities                                                        10,027               9,965

                    Notes payable                                                    10,605               7,989
  Other liabilities                                                                     537               1,390
  Mandatory redeemable preferred stock, at redemption value:
    Series B, 3,800,000 shares issued and outstanding                                                     4,286
    Series I, 420,857 shares issued and outstanding                                     855
                                                                                 ------------        ------------
    Total Liabilities                                                                22,024              23,630

Stockholders' Equity
  Preferred stock, par value $.02 per share, authorized
    5,000,000 shares
  Common stock, par value $.02 per share:
    authorized 65,000,000 shares; 41,865,077 issued
      at December 31, 2004 and 7,439,732 issued
        at December 31, 2003, including treasury shares                                 837                 149
  Capital in excess of par value                                                     41,651              38,354
  Accumulated retained-earnings deficit                                            (36,339)            (32,570)
  Accumulated other comprehensive loss - currency
    translation adjustment                                                          (1,189)               (844)
                                                                             ------------------------------------
                                                                                      4,960               5,089

    Cost of common stock in treasury, 413,500 shares                                (2,646)             (2,646)
                                                                             ------------------------------------
      Total stockholders' equity                                                      2,314               2,443
                                                                             ------------------------------------
  Total Liabilities and Stockholders' Equity                                   $     24,338        $     26,073
                                                                             ====================================
See accompanying notes.
</TABLE>





                                       29
<PAGE>



SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                     Year Ended December 31
(thousands, except share data)                               2004           2003            2002
------------------------------------------------------------------------------------------------------
<S>                                                    <C>             <C>           <C>
Revenues
     Hardware and software                             $      11,883   $     16,044  $       11,292
     Professional services                                     5,925          5,474           6,550
     Access services                                          10,933         10,563          11,499
                                                       --------------- ------------- -----------------
         Total revenues                                       28,741         32,081          29,341

Costs of Revenue
     Hardware and software                                     9,655         10,690           7,816
     Professional services                                     2,873          2,717           2,899
     Access services                                           8,980          8,813           8,539
                                                       --------------- ------------- -----------------
         Total costs of revenues                              21,508         22,220          19,254

     Gross Profit                                              7,233          9,861          10,087

Operating Expenses
     Sales and marketing                                       3,327          3,455           3,273
     Research and development                                  1,955          1,267           1,798
     General and administrative                                4,787          3,572           3,566
     Interest                                                    867            856             846
                                                       --------------- ------------- -----------------
         Total costs and expenses                             10,936          9,150           9,483
                                                       --------------- ------------- -----------------

Operating income (loss)                                       (3,703)           711             604

Other income, net                                                  5            133             419
                                                       --------------- ------------- -----------------

Income (loss) before income taxes                             (3,698)           844           1,023

     Income taxes (benefit)                                       71           (142)             81
                                                       --------------- ------------- -----------------

Net Income (Loss)                                      $      (3,769)  $        986  $          942
                                                       =============== ============= =================

Basic earnings (loss) per share                        $        (.18)  $        .14  $          .13
                                                       =============== ============= =================

Basic weighted-average shares                             20,890,686      7,026,232       7,026,232
                                                       =============== ============= =================

Diluted earnings (loss) per share                      $        (.18)  $        .13  $          .13
                                                       =============== ============= =================

Diluted weighted-average shares                           20,890,686      7,806,491       7,317,437
                                                       =============== ============= =================
</TABLE>

See accompanying notes.



                                       30
<PAGE>






SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>

                                                                    Accumulated      Accumulated
                                  Common Stock         Capital in     Retained-          Other
(thousands, except share data)  -----------------       Excess of     Earnings       Comprehensive   Treasury
                                Shares    Amount       Par Value      Deficit            Loss         Stock           Total
------------------------------------------------------------------------------------- -------------- ------------- -------------
<S>                            <C>         <C>        <C>           <C>               <C>            <C>           <C>
Balance January 1, 2002        7,439,732   $ 149      $  38,354     $ (34,498)        $  (999)       $ (2,646)     $     360

Net income                                                                942                                            942
Currency
   translation                                                                             81                             81
   adjustments
                                                                                                                   -------------
Comprehensive income                                                                                                   1,023
--------------------------------------------------------------------------------------------------------------------------------

Balance December 31, 2002      7,439,732     149         38,354       (33,556)           (918)         (2,646)         1,383

Net income                                                                986                                            986
Currency translation
   adjustments                                                                             74                             74
                                                                                                                   -------------
Comprehensive income                                                                                                   1,060
--------------------------------------------------------------------------------------------------------------------------------

Balance December 31, 2003      7,439,732     149         38,354       (32,570)           (844)         (2,646)         2,443

Net loss                                                               (3,769)                                        (3,769)
Currency translation
   adjustments                                                                           (345)                          (345)
                                                                                                                   -------------
Comprehensive loss                                                                                                    (4,114)
Exchange of common stock for
   debt                       34,425,345     688          3,712                                                        4,400
Common stock issuance costs                                (606)                                                        (606)
Fair value of stock options
issued to non-employees                                     191                                                          191
--------------------------------------------------------------------------------------------------------------------------------

Balance December 31, 2004     41,865,077   $ 837      $  41,651     $ (36,339)        $(1,189)       $ (2,646)     $   2,314
================================================================================================================================
</TABLE>

See accompanying notes.




                                       31
<PAGE>


<TABLE>
<CAPTION>
<S>                                                               <C>                  <C>                   <C>

SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                                                     Year Ended December 31
(thousands)                                                                    2004                 2003                  2002
------------------------------------------------------------------------------------- --------------------- --------------------
Operating Activities
     Net income (loss)                                            $          (3,769)   $            986      $            942
         Adjustments to reconcile net income (loss) to net
            cash provided (used) by operating activities:
         Depreciation                                                           404                 426                   425
         Amortization of customer service inventory and
             development costs                                                2,134               1,885                 2,355
         Amortization of deferred debt costs                                    119
         Accretion of interest on debt                                          105
         Accretion of interest on preferred stock                               128                 486                   254
         Fair value of common stock options granted to
             non-employees                                                      191
         Provision for losses on accounts receivable                            567                  22                    35
         Provision for slow-moving inventory                                    527                                        50
         Reversal of previously recorded liabilities                                               (183)                 (369)
         Changes in operating assets and liabilities:
             Accounts receivable                                              1,279                (549)                 (668)
             Inventories                                                     (2,648)                (28)               (2,634)
             Prepaid expenses and other                                         208                  (6)                  (87)
             Accounts payable                                                   499                 232                  (819)
             Accrued salaries and wages                                        (782)                457                  (353)
             Taxes other than income taxes                                     (117)                257                   (23)
             Income taxes                                                      (121)                144                    40
             Deferred revenue                                                   621                 570                   116
             Customer deposits                                                 (786)               (379)                  801
             Other                                                             (767)             (1,283)                 (233)
                                                                  ------------------- --------------------- --------------------
        Net cash provided (used) by operating activities                     (2,208)              3,037                  (168)

Investing Activities
     Acquisition related settlement                                                                                       209
     Purchases of plant and equipment, net                                     (329)               (173)                  (79)
                                                                  ------------------- --------------------- --------------------
        Net cash provided (used) by investing activities                       (329)               (173)                  130

Financing Activities
     Debt and equity transaction costs                                       (1,082)
     Proceeds from borrowings                                                 5,711               7,650                 4,376
     Principal payments on borrowings                                        (2,200)            (10,203)               (5,726)
                                                                  -------------------- -------------------- --------------------
        Net cash provided (used) by financing activities                      2,429              (2,553)               (1,350)

Increase (decrease) in cash and cash equivalents                               (108)                311                (1,388)
Cash and cash equivalents at beginning of year                                  585                 274                 1,662
                                                                  -------------------- -------------------- --------------------
Cash and Cash Equivalents at End of Year                          $             477    $            585     $             274
                                                                  ==================== ==================== ====================

Supplemental Cash Flow Information
Interest paid                                                     $             626    $            732     $             667
                                                                  ==================== ==================== ====================
Income taxes paid                                                 $             126    $             24     $              44
                                                                  ==================== ==================== ====================
See accompanying notes.

</TABLE>




                                       32
<PAGE>

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


NOTE A - DESCRIPTION OF BUSINESS

Scan-Optics,  Inc. and its  subsidiaries  (collectively,  the  Company)  combine
technology,  experience  and expertise to develop  cost-effective  solutions for
applications that include  government,  insurance,  assessment,  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 factors
include  (1)  the  effect  of  a  continued   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 to
customers, and (5) the stability of sole source suppliers.


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 have been eliminated in the consolidated
financial  statements.  Certain amounts have been reclassified to conform to the
current year presentation.

Use of Estimates:  The  preparation of financial  statements in conformity  with
accounting  principles  generally  accepted  in the  United  States  of  America
requires  management to make estimates and  assumptions  that affect the amounts
reported in them,  including the 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.  Significant estimates included in the financial statements relate to
asset valuation  allowances for potentially  uncollectible  accounts receivable;
slow-moving and obsolete inventories;  and deferred income tax assets.  Further,
other significant estimates relate to revenue recognition

Foreign  Currency  Translation:  All balance sheet accounts have been translated
using the  exchange  rates in effect at the  balance  sheet date.  Statement  of
operations accounts 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  accumulated  other  comprehensive  loss,  a
component of Stockholders' Equity.

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

Accounts  Receivable  and  Revenue  Recognition:  Revenues  relating to sales of
certain  equipment  (principally  optical character  recognition  equipment) are
recognized upon acceptance,  shipment, or


                                       33

<PAGE>


installation  depending on the contract terms and  conditions.  When  customers,
under  the terms of  specific  orders  or  contracts,  request  the  Company  to
manufacture  and invoice  the  equipment  on a bill and hold basis,  the Company
recognizes revenue based on an acceptance test that is certified by the customer
(Note O).  When  right of return  exists,  the  Company  recognizes  revenue  in
accordance  with SFAS 48,  Revenue  Recognition  When  Right of  Return  Exists.
Returns were not significant for any period presented.  At December 31, 2004 two
customers  represented 30% and 17%,  respectively,  of accounts  receivable.  At
December 31, 2003 one customer represented 33% of accounts receivable.

Revenues  under systems  integration  and  professional  services  contracts are
recognized on a proportionate  performance  basis,  based on 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  individual  project.  Under fixed
price  contracts,  the Company may encounter,  as has been the case with certain
contracts in prior years,  cost overruns caused by project  management  problems
and the 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 on a particular
contract,  such a loss  is  provided  for in the  period  it is  identified.  No
significant losses were required to be provided for any period presented.

The Company  provides  maintenance  services under  contracts with terms ranging
from nine to 36 months.  Revenues on activated contracts are recognized over the
term of the contract as the Company  fulfills its  obligation  for  performance.
Commencing  in the fourth  quarter of 2004,  revenues on contracts  that are not
expected to be activated are recognized  over the estimated final term for which
the Company may possibly be required to perform. Under this change in accounting
estimate, the Company recognized $405,000 of revenues on contracts for which its
obligation to perform is remote.

Accounts  receivable are recognized when billed under the contract terms.  Based
on certain pre-negotiated  contract terms billings may not coincide with revenue
recognition.  Revenues  earned  but not  yet  billable  are  shown  as  unbilled
receivables  until the  customer is actually  invoiced  in  accordance  with the
contract terms.

An allowance for potentially uncollectible accounts receivable is provided based
on  management's  assessment of each  customer's  current  financial  condition,
general  economic  and  industry   conditions  and  past  experience.   Accounts
receivable are charged to the allowance when deemed uncollectible.

Inventories:  Inventories of materials and component  parts,  and in-process and
finished goods are stated at the lower of cost (first-in,  first-out  method) or
market.  The  Company   periodically   provides  for  obsolete  and  slow-moving
inventories  based on historical  usage,  future  requirements  and  anticipated
demand.  The  fourth  quarter of 2004  includes  a  provision  of  $527,000  for
slow-moving  inventory.  As of December  31, 2004  allowances  for  obsolete and
slow-moving  inventories  were $1,764,000  ($1,268,000 as of December 31, 2003).
Service parts held and restricted  primarily for customer use under  maintenance
contracts are amortized  over four years.  As such,  service parts are stated at
amortized cost which is reviewed periodically for reasonableness.

Equipment and Leasehold  Improvements:  Equipment and leasehold improvements are
stated on the basis of cost.  Depreciation  is  computed  principally  using the
straight-line  method over the estimated

                                       34

<PAGE>


useful  lives  of  the  assets,  which  range  from  3 to  10  years.  Leasehold
improvements  are amortized over the useful life of the improvements or the life
of the lease, whichever is shorter.

Other Assets: Other assets consist primarily of capitalized software development
costs  and  deferred  debt  costs.   Certain  internal  and  external   software
development  costs are  capitalized  in accordance  with FASB  Statement No. 86,
Accounting for the Costs of Software to be Sold, Leased, or Otherwise  Marketed.
These costs are amortized on a straight-line  basis over the estimated  economic
life of the software.  Related  amortization  is greater than that computed on a
units sold basis.  Deferred debt costs are being  amortized over the term of the
debt.

Asset  Impairment:  Goodwill and other  long-lived  assets are reviewed at least
annually for impairment or whenever facts and circumstances  suggest they may be
impaired. There were no impairments for any of the years presented.

Goodwill:  Goodwill  consists  of the  excess  of cost  over the  fair  value of
identifiable  net assets of  businesses  acquired.  Goodwill is carried at cost,
less amortization thereon to January 1, 2002; the carrying amount of goodwill is
not in excess of its estimated recoverable amount.

Fair Value of  Financial  Instruments:  The  carrying  amounts  reported  in the
balance sheets for accounts  receivable,  accounts payable, and accrued expenses
and other liabilities  approximate fair value due to the immediate to short-term
maturity of these financial instruments. The fair values of the revolving credit
facility and term loan are determined  using current  interest rates for similar
instruments, as of December 31, 2004 and 2003 and approximate the carrying value
of these financial instruments.

Shipping Costs: Shipping costs are included in costs of revenue.

Advertising  Costs: The Company expenses the production costs of advertising the
first time the  advertising  takes place.  Advertising  costs ($171,000 in 2004,
$10,000  2003,  and  $12,000  in 2002) are  included  in  selling,  general  and
administrative expenses.

Income Taxes:  Deferred income taxes are provided for on 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 may
consider 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.

                                       35

<PAGE>



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,   Accounting  for  Stock-Based
Compensation. Options granted to non-employees are recorded at fair value.

The Company recognized  compensation expense of $191,000 in 2004 associated with
options granted to non-employees.

Pro forma information  regarding net income (loss) and earnings (loss) per share
determined  as if the Company  granted stock options under the fair value method
is  required by FASB  Statement  No.  123.  The fair value of these  options was
estimated at the date of grant using a Black-Scholes option pricing model.

For the purpose of pro-forma disclosures,  the estimated fair value of the stock
options at the date of grant was determined using a Black-Scholes option pricing
mode and is expensed  ratably over the vesting period of the grant,  which is 36
months for key  employees and 6 months for  nonemployee  members of the Board of
Directors.  Options for senior management that were granted on December 31, 2001
as part of the previous debt restructuring vested over six months. The Company's
pro-forma information is as follows:


<TABLE>
<CAPTION>
<S>                                                                          <C>              <C>             <C>

                                                                                          Year Ended December 31
              (thousands, except per share amounts)                                  2004             2003            2002
              -------------------------------------------------------------- ---------------- --------------- ----------------

              Net income (loss), as reported                                 $    (3,769)     $        986    $        942
              Stock option expense                                                  (815)              (93)           (199)
                                                                             ---------------- --------------- ----------------
              Pro forma net income (loss)                                    $    (4,584)     $        893    $        743
                                                                             ================ =============== ================

              Basic earnings (loss) per share, as reported                   $      (.18)     $        .14    $        .13
              Stock option expense                                                  (.04)             (.01)           (.03)
                                                                             ---------------- --------------- ----------------
              Pro forma basic earnings (loss) per share                      $      (.22)     $        .13    $        .10
                                                                             ================ =============== ================

              Diluted earnings (loss) per share, as reported                 $      (.18)     $        .13    $        .13
              Stock option expense                                                  (.04)             (.01)           (.03)
                                                                             ---------------- --------------- ----------------
              Pro forma diluted earnings (loss) per share                    $      (.22)     $        .12    $        .10
                                                                             ================ =============== ================
</TABLE>


The weighted-average fair value price of options granted was $.21, $.27 and $.34
for 2004, 2003, and 2002, respectively.

Option  valuation  models  require  the input of highly  subjective  assumptions
including  the expected  stock price  volatility.  The  assumptions  used in the
valuation model were: expected life-10 years; risk free interest rate of 4%, 3%,
and 7% for 2004, 2003, and 2002,  respectively and expected  volatility of .786,
1.102, and 1.39 for 2004, 2003, and 2002, respectively.

                                       36

<PAGE>


Earnings  (Loss) Per Share:  The following  table sets forth the  computation of
basic and diluted earnings (loss) per share:

<TABLE>
<CAPTION>
<S>                                                        <C>                     <C>                    <C>

                                                                              Year Ended December 31
(thousands, except share data)                                        2004                    2003                   2002
                                                       ----------------------- ---------------------- ----------------------
Numerator:
     Net earnings (loss)                                   $       (3,769)         $           986        $           942
                                                       ======================= ====================== ======================

Denominator:
     Denominator for basic earnings (loss)
     per share (weighted-average shares)                        20,890,686               7,026,232              7,026,232

     Effect of dilutive securities:
     Employee stock options                                                                780,259                291,205
                                                       ----------------------- ---------------------- ----------------------

     Denominator for diluted earnings (loss)
       per share (adjusted weighted-average
       shares and assumed conversions)                          20,890,686               7,806,491              7,317,437
                                                       ======================= ====================== ======================

Basic earnings (loss) per share                            $         (.18)         $           .14        $           .13
                                                       ======================= ====================== ======================

Diluted earnings (loss) per share                          $         (.18)         $           .13        $           .13
                                                       ======================= ====================== ======================

</TABLE>


New Accounting Pronouncements:

Statement of Financial  Accounting  Standards (FAS) No. 151, Inventory Costs, an
amendment  of ARB No.  43,  Chapter 4  requires  that  abnormal  amounts of idle
capacity and spoilage costs should be excluded from the cost of inventories  and
expensed when incurred.  FAS No. 151 is effective for fiscal  periods  beginning
after June 15,  2005.  The  Company  does not  expect  this  standard  to have a
material effect on its financial statements upon adoption.

FAS No. 123R, Share-Based Payment requires that a public entity measure the cost
of equity based service awards based on the grant-date  fair value of the award.
That cost  will be  recognized  over the  period  during  which an  employee  is
required to provide service in exchange for the award or the vesting period.  No
compensation  cost is recognized for equity  instruments  for which employees do
not render the requisite  service.  A public entity will  initially  measure the
cost of liability  based  service  awards based on current fair value.  The fair
value of those awards will be  re-measured  subsequently  at each reporting date
through the settlement  date.  Changes in fair value during the requisite period
be recognized as  compensation  cost over that period.  FAS 123R is required for
fiscal periods  beginning after June 15, 2005. The Company has not yet attempted
to evaluate the likely effects on its financial statements.

                                       37

<PAGE>


NOTE C - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS

Unbilled  amounts in accounts  receivable  under  contracts in progress were $.3
million  and $.4 million at December  31, 2004 and 2003,  respectively,  and are
recoverable  from the customer upon  completion  of the phase or milestone.  The
Company  estimates that  substantially all unbilled amounts will be collected in
2005.


NOTE D - INVENTORIES

The components of inventories were as follows:
                                                               December 31
(thousands)                                                2004             2003
--------------------------------------------------------------------------------
Finished goods                                        $      57          $    57
Work-in-process                                             644            1,066
Service parts                                             2,713            3,291
Materials and component parts                             4,047            2,868
                                                      --------------------------
                                                      $   7,461          $ 7,282
                                                      ==========================

NOTE E - OTHER ASSETS

The following table summarizes other assets:



                                                           December 31,
                                                       2004          2003
                                                   -------------------------

Software development cost                          $     1,120   $      960
Deferred debt costs                                        476            -
Cash surrender value of life insurance policy              137          136
                                                   -------------------------
                                                         1,733        1,096
Accumulated amortization                                  (311)           -
                                                   -------------------------
                                                   $     1,422   $    1,096
                                                   =========================


The Company capitalized  software  development costs of $160,000 and $960,000 in
2004 and 2003,  respectively.  The Company  commenced  amortizing these costs in
2004 over a five year period.  Total amortization of software  development costs
was $192,000 in 2004. In connection with the new credit  agreement  disclosed in
Note F, the Company incurred  $1,082,000 of transaction  costs of which $476,000
were  allocated to debt.  These costs were deferred and are being  recognized in
expense over the three year term of the credit agreement.  Total amortization of
deferred debt costs was $119,000 in 2004.

The  estimated  aggregate  amortization  expense  for  each  of  the  next  five
succeeding  years follows:  2005 - $384,000,  2006 - $384,000,  2007 - $264,000,
2008 - $225,000, and 2009 - $28,000.


                                       38

<PAGE>



NOTE F - CREDIT ARRANGEMENTS


Effective March 30, 2004, the Company  entered into a new credit  agreement (the
Credit  Agreement) with lenders  affiliated with Patriarch  Partners,  LLC. (the
Lenders).  Among other things, under the Credit Agreement the Company's existing
revolving and term loans with outstanding amounts of $9.0 million were exchanged
for a $9.0 million term loan, a $2.5  million  revolving  credit  facility and a
$1.5  million  term loan working  capital  facility.  The $9.0 million term loan
bears  interest  at prime plus 2% and is payable in two annual  installments  of
$90,000 on April 1, 2005 and 2006 with the  balance of  $8,820,000  due on March
30, 2007.

In the second quarter of 2004, the Company  borrowed $1.5 million under the term
loan working  capital  facility of the Credit  Agreement.  Such  borrowings bear
interest  at prime.  The  Credit  Agreement  requires  the  Company to repay the
borrowed  amount plus  $500,000 at March 30, 2007.  The  additional  $500,000 is
being expensed as interest and accreted to debt over the term of the loan.

As of December  31,  2004,  $1 million was  outstanding  under the $2.5  million
revolving  credit  facility  portion  of  the  Credit   Agreement.   Outstanding
borrowings bear interest at prime plus 2% and are due March 30, 2007.

As part of the Credit  Agreement  the  Company  is  required  to meet  financial
covenants with respect to backlog,  capital expenditures and EBITDA. The Company
is in compliance with the modified covenants.

On August 6, 2004, the Company  completed a  recapitalization  with its Lenders,
which had been  approved by the  Company's  shareholders  on July 15, 2004.  The
recapitalization  included,  among other  terms,  the  cancellation  of the $3.8
million of Mandatorily  Redeemable Series B Preferred Stock, including dividends
of $0.6 million and  outstanding  warrants held by the Lenders,  in exchange for
34,425,345  shares  of  Common  Stock.  As such,  the  Lenders  own 79.8% of the
fully-diluted  Common Stock of the Company at the date of  issuance,  subject to
dilution for certain  current and future  compensatory  stock options granted by
the  Company.  Due to the  compensatory  stock  options,  6,470,929  shares  are
redeemable if the 2001 executive options are exercised.  The Company also issued
an aggregate of 420,857  shares of 4% Series I Preferred  Stock with a mandatory
redemption on March 30, 2007 for $841,714 plus unpaid dividends at 4%.

Effective  upon the  closing  of the  recapitalization  on August 6,  2004,  the
maturity date for all of the Company's  secured  indebtedness to the Lenders was
extended through March 30, 2007.

Borrowings  under the  Credit  Agreement  are  secured  by all of the  Company's
assets.



NOTE G - CAPITAL STOCK

An amended  and  restated  certificate  of  incorporation  was  approved  by the
shareholders  at the Company's  annual  meeting held July 15, 2004. As such, the
total  authorized   capital  stock  of  the  Corporation  is  70,000,000  shares
consisting  of 65,000,000  shares of Common Stock,  par value $.02 per


                                       39

<PAGE>


share and 5,000,000  shares of Preferred  Stock, par value $.02 per share. As of
December 31, 2004  420,857  shares of Preferred  Stock have been  designated  as
Series I, with dividends at 4%, and are outstanding.

On August 6, 2004, the Company issued 420,857 shares of Series I Preferred Stock
in exchange for cancellation of lease obligations  aggregating $842,000 that the
Lenders  acquired from the lessor.  The Series I Preferred  Stock and accrued 4%
annual  dividends  are  redeemable  March 30, 2007.  As of December 31, 2004 the
carrying value of Preferred Stock is $855,000.  Accumulated  deferred  dividends
were $13,000 as of December 31, 2004.

The  recapitalization  which was effective August 6, 2004 included,  among other
terms,  the  cancellation  of the  380,000  shares of $3.8  million  mandatorily
redeemable Series B Redeemable Preferred Stock, par value $.02, the cancellation
of existing warrants  exercisable for Common Stock held by the Lenders,  and the
issuance of  34,425,345  shares of Common  Stock of the Company to the  Lenders.
There are  41,451,577  shares  issued and  outstanding  as of December 31, 2004.
There are also 413,500 shares of treasury stock.

At December 31, 2004, the Company had reserved  1,292,983 shares of common stock
for the issuance or exercise of stock options.

                                       40

<PAGE>



NOTE H - STOCK OPTION PLANS

The Company has six 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 senior  management that were granted on December 31, 2001 as part of
the total debt  restructuring  are not  exercisable  until six months  after the
grant  thereof  and  certain  other  options  granted  in 2004  under the senior
executive stock option plan were  exercisable in full upon grant of such option.
Options for Directors are also 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, 2004:


<TABLE>
<CAPTION>
<S>                                                                     <C>        <C>               <C>               <C>

                                                                  Number of            Weighted              Option Price
                                                                   Shares           Average Price              Per Share
----------------------------------------------------------- ---------------------- ----------------- ------------------------------
Outstanding January 1, 2002 (782,261 exercisable)                       2,198,083  $          1.41   $    .24   to     $9.19
     Granted                                                               30,000              .34        .34   to       .34
     Canceled                                                           (236,800)             1.65        .24   to      9.19
                                                            ---------------------- ----------------- ------------------------------
Outstanding December 31, 2002 (1,869,142 exercisable)                   1,991,283             1.37        .24   to      9.19

2003 Activity
-------------
     Granted                                                              717,500              .29        .28   to       .55
     Canceled                                                            (56,100)             2.67        .31   to      3.88
                                                            ---------------------- ----------------- ------------------------------
Outstanding December 31, 2003 (1,970,183 exercisable)                   2,652,683             1.05        .24   to      9.19

2004 Activity
-------------
     Granted                                                            5,485,929              .25        .25   to       .66
     Canceled                                                         (1,153,608)              .90        .24   to      7.50
                                                            ---------------------- ----------------- ------------------------------
Outstanding December 31, 2004 (6,579,984 exercisable)                   6,985,004  $            .45  $    .24   to     $9.19
                                                            ====================== ================= ==============================
</TABLE>


The  weighted-average  price of options exercisable was $.46, $1.31 and $1.43 at
December 31, 2004, 2003, and 2002, respectively.  The weighted-average remaining
contractual life of the options outstanding at December 31, 2004 was 9 years.

                                       41


<PAGE>


<TABLE>
<CAPTION>
<C>                                   <C>                <C>                <C>             <C>                         <C>


                         Options Outstanding                                                Options Exercisable
-------------------------------------------------------------------------    ------------------------------------------------------
                                                      Weighted
                                                      Average
                                                     Remaining          Weighted                                   Weighted
                                   Number           Contractual         Average                  Number             Average
Range of Exercise Prices        Outstanding         Life (Years)      Exercise Price        Exercisable         Exercise Price
---------------------------- ------------------- ------------------- ------------------  ------------------- ----------------------
$  .24 to $ .60                       6,540,671          9                  $      .25        6,135,651             $      .25
$  .61 to $1.50                         122,500          7                         .88          122,500                    .88
$1.51 to $3.75                          246,333          3                        3.39          246,333                   3.39
$3.76 to $9.19                           75,500          2                        6.98           75,500                   6.98
---------------------------- ------------------- ------------------- ------------------  ------------------- ----------------------
                                      6,985,004                                               6,579,984
                             ===================                                         ===================

</TABLE>


At December 31, 2004 there were 3,470,511  options  available for grant of which
261,500 were reserved for the Directors.


NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS

During  2004,  2003 and 2002,  the Company  completed  a number of small  custom
development   contracts   for  specific   customers   resulting  in  revenue  of
approximately $79,000, $200,000 and $43,000, respectively. 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;  in 2001, the employer match was increased to 67% of the first
6%.  The  Company's  contributions  to this plan  were  $378,000,  $346,000  and
$346,000, in 2004, 2003 and 2002,  respectively.  Effective January 15, 2005 the
Company suspended its matching contribution.

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 over a ten year period. The ESOP loan was guaranteed by the
Company and the outstanding  balance of the loan was repaid in 1991. At December
31,  1998,  all shares had been  allocated.  The  Company did

                                       42

<PAGE>


not  allocate  any  additional  shares  to the Plan in 2004,  2003 or 2002.  The
Company,  at its  discretion,  may make  annual  allocations  to the Plan in the
future. There were no expenses related to the Plan in 2004, 2003 and 2002.

The Company  terminated  the Plan  effective  December 31, 2003;  its assets are
expected  to be  distributed  in 2005.  There will be no  significant  financial
impact to the Company.


NOTE K - INCOME TAXES

At December  31, 2004,  the Company has U.S.  federal and state  operating  loss
carry forwards of approximately  $32,400,000 and $29,900,000  respectively.  The
U.S.  federal  and state net  operating  loss carry  forwards  expire  from 2005
through  2024. In 2004 the Company's  ability for  utilization  of net operating
loss carry forwards was significantly restricted due to the change in control as
a result of the recapitalization  (see Note F for further details).  At December
31, 2004, the Company has approximately $3,500,000 and $800,000 of net operating
loss carry forwards for the United Kingdom and Germany, respectively. These loss
carry  forwards  expire from 2005 through 2014.  There are no net operating loss
carry forwards for Canada.

A summary of income (loss) before income taxes follows:


                                                Year Ended December 31
(thousands)                                 2004           2003           2002
--------------------------------------------------------------------------------
Domestic                            $    (3,739)     $     708        $     811
Foreign                                       41           136              212
                                    --------------------------------------------
Income (loss) before income taxes   $    (3,698)     $     844        $   1,023
                                    ============================================

Income taxes (benefit) follow:
                                                Year Ended December 31
(thousands)                                 2004           2003           2002
--------------------------------------------------------------------------------
Current :
  State                               $       30     $      40        $      80
  Federal benefit                                        (321)
  Foreign                                     41           139                1
                                      ------------------------------------------
Total current                                 71         (142)               81

  Deferred                                    -             -                 -
                                      ------------------------------------------
Total                                 $       71      $  (142)        $      81
                                      ==========================================

                                       43

<PAGE>



Significant components of deferred income tax assets and (liabilities) follow:

<TABLE>
<CAPTION>
<S>                                                                            <C>               <C>

                                                                                       December 31
(thousands)                                                                        2004               2003
-----------------------------------------------------------------------------------------------------------
 Deferred income tax assets:
   Net operating loss carry forward                                            $  13,890         $  12,109
   Alternative minimum tax credit carry forward                                      168               168
   Foreign equipment                                                                  92                92
   Inventories                                                                       807               584
   Bonus accrual                                                                                        26
   Accounts receivable allowance                                                      81               354
    Vacation accrual                                                                 202               183
   Other                                                                             110               109
                                                                               ---------------------------
      Total deferred income tax assets                                            15,350            13,625

Deferred income tax liabilities:
Goodwill                                                                           (511)             (175)
Plant and equipment                                                                (215)             (151)
                                                                               ---------------------------
      Total deferred income tax liabilities                                        (726)             (326)

Valuation allowance                                                             (14,624)          (13,299)
                                                                               ---------------------------
      Net deferred income tax                                                  $       -         $       -
                                                                               ===========================
</TABLE>

A reconciliation  of income taxes computed using the U.S.  statutory rate to the
provision (benefit) for income taxes follows:

<TABLE>
<CAPTION>
<S>                                                           <C>                    <C>                   <C>

                                                                                    Year Ended December 31
                                                                            2004                 2003                   2002
------------------------------------------------------------- ---------------------- --------------------- ----------------------
Federal income taxes at statutory rate                        $            (1,271)   $                287  $               348
    State income taxes, net of federal benefit                                  30                     66                   80
    Foreign income taxes                                                        41                     93
    Valuation allowance, net of deferred income
       tax adjustments                                                       1,271                  (382)                (348)
    Adjustment of tax reserves                                                                      (206)
    Other                                                                                                                    1
                                                              ---------------------- --------------------- ----------------------
Provision (benefit) for income taxes                          $                 71   $              (142)  $                81
                                                              ====================== ===================== ======================

</TABLE>


The tax  reserve  decrease  in 2003 of  $206,000  or $.03 per  diluted  share is
directly  related to the reduction of potential tax  exposures  associated  with
certain state and foreign items.

                                       44

<PAGE>



NOTE L - LEASE COMMITMENTS

The  Company's  principal  lease  commitment  is for its  corporate  office  and
manufacturing  facility  in  Manchester,  Connecticut.  This  lease  expires  on
December 31, 2006.  The Company  also has capital  leases for office  equipment.
Minimum rental payments for these  noncancelable  leases, with terms of one year
or more as of December 31, 2004, follow:


(thousands) Operating Leases Capital Lease

2005                                        $   450                $     84
2006                                            448                      74
2007                                             52                      67
2008                                             52
2009                                             52
Thereafter                                      208
                                            --------------------------------
Total minimum lease payments                $ 1,262                     225
Amounts representing interest               =======                     (35)
                                                                   ---------
Present value of net minimum lease payments                        $    190
                                                                   =========

Rental expense for 2004,  2003, and 2002 was $445,000,  $470,000,  and $681,000,
respectively.

The cost of assets  recorded under capital leases and  accumulated  depreciation
thereon was $322,000 and $125,000 as of December 31, 2004 ($322,000 and $43,000,
at December  31,  2003).  All assets  under  capital  leases are  classified  as
equipment.  Amortization  of assets recorded under capital leases is included in
depreciation expense.

Long term  capital  leases are  included in other long term  liabilities  on the
balance sheet.


NOTE M - CONTINGENCIES

As of December  31,  2004,  the Company had settled all  outstanding  claims and
contingencies  pending during 2004 with no  significant  effect on cash flows or
operating results.

                                       45

<PAGE>



NOTE N - SEGMENT INFORMATION

The Company views its business in three distinct operating  segments:  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>
<S>                                                   <C>                    <C>                       <C>

                                                                   Year Ended December 31
(thousands)                                                2004                      2003                     2002
----------------------------------------------------------------------------------------------------------------------

Revenues
  Solutions and products                              $     15,886           $        21,108           $      16,376
  Access services                                           10,933                    10,563                  11,499
  Contract manufacturing services                            1,922                       410                   1,466
                                                      --------------         -----------------         ---------------
    Total revenues                                          28,741                    32,081                  29,341

Cost of solutions and products                              12,528                    13,407                  10,715
Service expenses                                             8,980                     8,813                   8,539
                                                      --------------         -----------------         ---------------

    Gross profit margin                                      7,233                     9,861                  10,087

  Operating expenses, net                                   10,931                     9,017                   9,064
                                                      --------------         -----------------         ---------------

Income (loss) before income taxes                     $    (3,698)           $           844           $       1,023
                                                      ==============         =================         ===============

Total assets                                          $     24,338           $        26,073           $      26,406
                                                      ==============         =================         ===============
Total  expenditures  for  additions to long-lived
assets                                                $        329           $           173           $          79
                                                      ==============         =================         ===============
</TABLE>

The Solutions and Products  Division  includes the sale of hardware and software
products  as well as  professional  services.  Contract  Manufacturing  Services
provides  assembly and test services under  contracts with customers who develop
and sell a variety of equipment.

In 2004 the Company  derived 11% of its total revenue from Mitsui & Co Ltd., one
of the Company's  distributors in Japan. In 2003, the Company derived 23% of its
total revenue from Northrop  Grumman,  IT Inc. No other  customer  accounted for
more than 10% of total revenue for any year presented.

The Company has international  distributors located in 13 countries and covering
six continents. All international sales other than sales originating from the UK
and Canadian  subsidiaries are denominated in United States dollars.  Changes in
the economic  climates of foreign  markets could have an  unfavorable  impact on
future international sales.


                                       46

<PAGE>



Export sales by geographic  area (based on the location of the customer) were as
follows:
<TABLE>
<CAPTION>
<S>                                            <C>                 <C>   <C>               <C>    <C>             <C>

                                                                       Year Ended December 31
(thousands)                                              2004                    2003                     2002
----------------------------------------------------------------------------------------------------------------------

Latin America                                  $           82      2%    $        124      12%    $         72    24%
Europe                                                    161      5                        0              149    49
Pacific Rim                                             3,302     93              944      88               81    27
                                             -------------------------------------------------------------------------
                                               $        3,545    100%    $      1,068     100%    $        302   100%
                                             =========================================================================

</TABLE>

Export sales  represented  22%, 5%, and 2% of the Solutions and Products Segment
revenues for 2004,  2003,  and 2002,  respectively.  There are no exports  sales
derived from the Company's  Access  Services  Segment or Contract  Manufacturing
Services Segment.


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  acceptance  test that is certified by the customer.  Revenues  recorded
during 2004, 2003, and 2002 included bill and hold  transactions of $.1 million,
$2.3 million and $1.3 million,  respectively.  Accounts receivable included bill
and hold receivables of $.1 million at December 31, 2004. There were no accounts
receivable associated with bill and hold transactions at December 31, 2003.


                                       47


<PAGE>



NOTE P - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Following is a summary of quarterly results of operations.

<TABLE>
<CAPTION>
<S>                                               <C>              <C>              <C>                <C>

(thousands, except per share amounts)                     March          June           September          December
-------------------------------------------------------------------------------------------------------------------

2004
----
Revenues                                          $       7,333    $    6,878       $       6,187      $      8,343
Cost of product sales and service expenses                5,816         5,178               4,327             6,187
Net loss                                                  (712)       (1,619)               (663)             (775)
Basic earnings (loss) per share                           (.10)         (.23)               (.02)             (.02)
Diluted earnings (loss) per share                         (.10)         (.23)               (.02)             (.02)

2003
----
Revenues                                                  8,110         8,107               7,365             8,499
Cost of product sales and service expenses                5,527         5,374               5,227             6,092
Net income                                                  196           214                  12               564
Basic earnings per share                                    .03           .03                 .00               .08
Diluted earnings per share                                  .03           .03                 .00               .07

</TABLE>


Fourth  quarter 2004 net loss of $775,000  includes a provision  for slow moving
inventory  adjustment  of $527,000 or $.01 per share.  In addition,  the Company
recognized  $405,000  or $.01 per  share of  revenue  applicable  to a change in
accounting  estimate for revenues on maintenance service contracts for which the
Company's obligation to perform is remote.

The second quarter 2004 net loss of $1,619,000  includes a $543,000 provision or
$.07 per share for an  account  receivable  as a result of the  settlement  of a
legal action.

Fourth quarter 2003 net income of $564,000 includes a tax benefit of $206,000 or
$.03 per share due to a reduction in the tax reserves.



NOTE Q - SUBSEQUENT EVENTS

On March 9, 2005,  the Company  received from  attorneys  representing  James C.
Mavel,  the  former  Chief  Executive  Officer  and  President,   a  "notice  of
termination"  pursuant to his Employment Agreement and asserting  entitlement to
severance  compensation under the agreement.  The Company intends to investigate
the  assertions  promptly  and raise all  available  defenses.  While,  based on
currently available  information,  the Company does not believe that Mr. Mavel's
claim to severance  compensation is supported by the Employment Agreement or the
facts,  should  Mr.  Mavel's  claim be  supported,  the  Company  believes  that
severance compensation would not exceed $1.3 million.

                                       48


<PAGE>




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


Previously reported on Form 8-K filed October 13, 2004.




ITEM 9A - DISCLOSURE CONTROLS AND PROCEDURES
--------------------------------------------

The Company  evaluated the design and operation of its  disclosure  controls and
procedures  to  determine  whether  they  are  effective  in  ensuring  that the
disclosure  of  required  information  is  timely  made in  accordance  with the
Exchange Act and the rules and forms of the Securities and Exchange  Commission.
This  evaluation was made under the supervision  and with the  participation  of
management,  including the Company's  principal  executive officer and principal
financial officer,  as of the end of the period covered by this Annual Report on
Form 10-K. The principal  executive officer and principal financial officer have
concluded,  based on their review,  that the Company's  disclosure  controls and
procedures,  as defined at  Exchange  Act Rules  13a-15(e)  and  15d-15(e),  are
effective to ensure that information  required to be disclosed by the Company in
reports that it files under the Exchange Act is recorded, processed,  summarized
and  reported  within the time  periods  specified  in  Securities  and Exchange
Commission  rules and forms. No significant  changes were made during any fiscal
quarter in 2004 to the  Company's  internal  controls or other  factors that has
materially affected, or is reasonably likely to materially affect, the Company's
internal controls and financial reporting.


                                       49

<PAGE>


                                    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 to be filed under  Regulation 14A for
the 2005 Annual Meeting of Stockholders and is incorporated  herein by reference
and made a part hereof.

EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT

Officers  of the  Company  as of March 22,  2005 are set  forth in the  schedule
below.

<TABLE>
<CAPTION>
<S>                                 <C>         <C>                                          <C>
                                                                                             Officer
Name                                Age         Principal Occupation:                          Since
----------------------------------------------------------------------------------------------------
Logan Clarke, Jr.                   77          Acting Chief Executive Officer
                                                and President                                  2005

Joseph P. Crouch                    42          Vice President -
                                                Manufacturing Services Division                1999

Richard C. Goyette                  53          Vice President -
                                                Sales and Marketing                            1996

Richard D. Harris                   44          Corporate Secretary                            2001

Joel K. Howser                      57          Vice President -
                                                Software Development                           1998

Peter H. Stelling                   54          Chief Financial Officer, Vice
                                                President, Treasurer and                       2004
                                                Assistant Corporate Secretary

Paul M. Yantus                      43          Chief Operating Officer                        2005

</TABLE>

                                       50


<PAGE>


Mr.  Clarke  has been a Director  of  Scan-Optics  since 1981 and was  appointed
Acting Chief  Executive  Officer and President in March 2005. He had  previously
served as Interim  Executive  Director of Southeast Area  Technology  Center,  a
business  incubator  and  revolving  loan fund  from  1995 to 1996,  independent
management  consultant from 1990 to 1995, as Executive Vice President of Society
for  Savings,  a  savings  bank,  from  1986 to 1990,  as Dean of the  School of
Management  at The Hartford  Graduate  Center from  1983-1986  and a lecturer in
management from  1979-1983.  Prior to 1979, Mr. Clarke served in multiple senior
management positions in the banking industry.

Mr. Crouch joined the Company in March 1999 and was appointed 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.

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 - Sales and Marketing.

Mr. Harris  joined the law firm of Day,  Berry and Howard LLP in 1990 and became
partner in 1998.  He was  appointed 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. He is currently Vice President - Software Development.

Mr. Stelling joined the Company in 2003 as Vice President of Finance and in 2004
was named Chief  Financial  Officer,  Vice  President,  Treasurer  and Assistant
Corporate  Secretary.  In his prior assignment,  he was Senior Vice president of
Finance and Chief  Financial  Officer of Gale Group,  an  operating  unit of the
Thomson  Corporation.  Prior to Gale, Mr.  Stelling  served as Vice President of
Finance at Chambers Engraving Group, a unit of  Dyson-Kissner-Moran,  Inc, a New
York based investment firm.

Mr.  Yantus,  joined the Company in 2005 as Chief  Operating  Officer.  Prior to
joining the Company, Mr. Yantus was a founder and President of Espire Marketing,
Inc., a web-based  solutions  provider.  Prior to founding  Espire,  Mr.  Yantus
served in various  positions at MSX  International,  a company  specializing  in
business   process    outsourcing   and   staffing,    including   Senior   Vice
President--Business    Process    Outsourcing   and   IT    (2002-2003),    Vice
President--Business   and   Technology   Services   (2001-2002),   and   General
Manager--Integrated  Information Solutions (1999-2001).  Prior to his employment
with MSX  International  Mr.  Yantus  held senior  positions  at Danka and Lason
Systems.


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.

                                       51

<PAGE>

ITEM 11 - EXECUTIVE COMPENSATION
--------------------------------

This  information is included in the Company's  definitive proxy statement to be
filed under  Regulation 14A for the 2005 Annual Meeting of  Stockholders  and is
incorporated herein by reference.

                                       52

<PAGE>


ITEM 12 - SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT AND
--------------------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS
---------------------------

For  information  with respect to the security  ownership of the  Directors  and
Executive Officers and related stockholders  matters, see the Proxy Statement to
be  filed  under  Regulation  14A for  the  Company's  2005  Annual  Meeting  of
Shareholders,  which is  incorporated by reference  herein.  The Company has six
equity  compensation  plans as of December 31, 2004.  See Note H to the Notes to
Consolidated  Financial  Statements  of the Company  included in this report for
additional   information  regarding  these  plans.  The  following  table  gives
information  about the Company's  equity  compensation  plans as of December 31,
2004.

<TABLE>
<CAPTION>
<S>                                                     <C>                      <C>                         <C>


                                                                                                  Number of shares of Common
                                                                                                   Stock remaining available
                                                 Number of shares of                               for future issuance under
                                                 Common Stock to be         Weighted -average      equity compensation plans
                                               issued upon exercise of      exercise price of          (excluding shares
                                                outstanding options,      outstanding options,      reflected in the first
                Plan Category                    warrants and rights       warrants and rights              column)
------------------------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by stockholders                          1,292,983                $      1.32                 2,654,472


Equity compensation plans not approved
by stockholders:
     Senior management options                          5,692,021                       .25                    816,039
                                              --------------------------------------------------------------------------
                                                        6,985,004                $      .45                  3,470,511
                                              ==========================================================================

</TABLE>


The Company's equity  compensation plan that was not approved by stockholders is
the Senior  Executive  Stock Option Plan.  Under the Plan,  individuals who were
senior  executive  officers of the Company as of December 31, 2001 were eligible
to receive a grant of a  non-qualified  stock  option to  purchase  one share of
common stock for each dollar of such  individual's  annual salary as of December
31, 2001; provided, however, that the individual was required to remain employed
until  June 30,  2002  before the right to  exercise  the  option  accrued.  The
exercise price for such options was $0.24, the closing price of the common stock
on  December  31,  2001.  This plan was  amended  and  restated  by our Board of
Directors on April 26, 2004 to permit  option  grants to executive  officers who
were employed by  Scan-Optics  after December 31, 2001 and to make other certain
changes   to  the   plan   and,   effective   upon  the   consummation   of  the
recapitalization,  to  increase  the number of shares  available  thereunder  to
6,815,114 shares.  Options were granted on April 26, 2004 to two individuals for
an aggregate of 55,000 shares of common stock at $0.66, the closing price of the
common stock on such date. In connection with the recapitalization,  each holder
of options ("Old Options") was granted additional  options


                                       53

<PAGE>


exercisable for 5.30 shares for each share issuable under the Old Options.  When
any options are  exercised  under the Senior  Executive  Stock Option Plan,  the
Lenders will transfer a like number of shares to the Company for their par value
to cover the option  exercise.  In this way,  only the Lenders,  and none of the
stockholders,  will  suffer  dilution  upon the  exercise of such  options.  All
options granted under the plan on December 31, 2001 were  exercisable on the six
month  anniversary of the date of grant and all options granted  thereafter were
immediately exercisable in full as of the date of grant.


See Note H to the Notes to  Consolidated  Financial  Statements  of the  Company
included in this report for additional information.

                                       54

<PAGE>


ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------

This  information is included under the caption  "Certain  Transactions"  in the
Company's  definitive  proxy statement to be filed under  Regulation 14A for the
2005 Annual Meeting of Stockholders and is incorporated herein by reference.



ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
------------------------------------------------

This  information is included under the caption  "Principal  Accountant Fees and
Services" in the Company's  definitive  proxy  statement to be filed pursuant to
Regulation 14A for the 2005 Annual Meeting of  Stockholders  and is incorporated
by reference.



                                       55


<PAGE>

                                     PART IV

ITEM 15 - 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 UHY LLP, Independent Registered Public Accounting Firm

          Report of Ernst & Young LLP, Independent  Registered Public Accounting
          Firm

          Consolidated Balance Sheets at December 31, 2004 and 2003

          Consolidated Statements of Operations for the years ended December 31,
          2004, 2003 and 2002

          Consolidated  Statements of  Stockholders'  Equity for the years ended
          December 31, 2004, 2003 and 2002

          Consolidated Statements of Cash Flows for the years ended December 31,
          2004, 2003 and 2002

          Notes to Consolidated Financial Statements - December 31, 2004

     (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)  Amended and Restated  Certificate of Incorporation  dated July
                  16,  2004 filed as  Exhibit  10.1 to the  Company's  quarterly
                  report on Form 10-Q filed November 12, 2004.


          3.1(b)  Certificate   of   Designations,   Preferences,   Rights   and
                  Restrictions for 4% Series I Redeemable Preferred  Stock dated
                  July 16, 2004.


                                       56
<PAGE>

         *3.2     Restated  By-laws  of the  Company,  as  amended  is  filed as
                  Exhibit 3.2 in the Company's  Annual Report on Form 10-K filed
                  for the year ended December 31, 2002.

         *+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 10.9 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.

         *+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.

                                       57


<PAGE>

         *+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  The  Scan-Optics,  Inc.  Amended and Restated Senior Executive
                  Stock  Option Plan is filed as Exhibit  10.3 to the  Company's
                  Quarterly Report on Form 10-Q.

         *+10.16  The Scan-Optics,  Inc. 2002 Incentive and Non-Qualified  Stock
                  Option Plan.

         *10.17   Third Amended and Restated Credit  Agreement dated as of March
                  30,  2004  among   Scan-Optics,   Inc.,  the  subsidiaries  of
                  Scan-Optics,   the  lenders   parties  thereto  and  Patriarch
                  Partners  Agency  Services,  LLC,  as agent,  filed as Exhibit
                  10.20 to the  Company's  Annual  Report on Form 10-K filed for
                  the year ended December 31, 2003.

         *+10.18  Executive  Severance  Agreement  dated as of April 1, 2004, by
                  and  between  the  Company  and  Peter H.  Stelling,  filed as
                  Exhibit 10.1 to the  Company's  Quarterly  Report on Form 10-Q
                  filed August 16, 2004.

         *+10.19  Scan-Optics,  Inc.  2004  Incentive  and  Non-Qualified  Stock
                  Option Plan filed as Exhibit 10.2 to the  Company's  Quarterly
                  Report on Form 10-Q filed August 16, 2004.

         *+10.20  Employment Agreement effective as of March 7, 2005 between the
                  Company and Paul Yantus,  filed as Exhibit 10.1 to a report on
                  Form 8-K filed by the Company on March 10, 2005.

         *10.21   Second  Amended  and  Restated   Subscription   Agreement  and
                  Repurchase  Agreement dated as of August 6, 2004,  between the
                  Company and ARK CLO 2000-1,  LIMITED, filed as Exhibit 99.1 to
                  the Company's report on Form 8-K filed on August 6, 2004.

         *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.

         23.1     Consent of UHY LLP, Independent Registered  Public  Accounting
                  Firm.

         23.2     Consent  of Ernst & Young LLP, Independent  Registered  Public
                  Accounting Firm.


         31.1     Certificate of the Acting Chief Executive  Officer pursuant to
                  Section 302 of the Sarbanes-Oxley Act of 2002.

         31.2     Certificate of the Chief Financial Officer pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002.


                                       58

<PAGE>


         32.1     Certification  of Acting Chief Executive  Officer  pursuant to
                  Section 906 of the Sarbanes-Oxley Act.

         32.2     Certification  of Chief Financial  Officer pursuant to Section
                  906 of the Sarbanes-Oxley Act.


         * 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
                  --------------------

                  Report on Form 8-K was filed  October  13, 2004 for Changes in
                  Registrant's Certifying Accountant.

                  Report on Form 8-K was filed November 10, 2004 regarding third
                  quarter of 2004 earnings.

                  Report on Form 8-K was filed  November  12, 2004 and  November
                  24, 2004 for the Election of Directors.

         (c)      Exhibits
                  --------

                  The exhibits required by this item are included herein.

         (d)      Financial Statement Schedule
                  ----------------------------

                  The  response  to this  portion of Item 15 is  submitted  as a
                  separate section of this report.


                                       59


<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/ Logan Clarke, Jr.
                             ---------------------------------
                            Logan Clarke, Jr.
                            Acting Chief Executive Officer and
                            President
                            Date:        March 25, 2005


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

/s/ Logan Clarke Jr.
---------------------------
Logan Clarke Jr.                   Acting Chief Executive Officer, President
                                   and a Director (Principal Executive Officer)
                                   Date:        March 25, 2005
/s/ Peter H. Stelling
---------------------------
Peter H. Stelling                  Chief Financial Officer, Vice President and
                                   Treasurer
                                   (Principal Financial and Accounting Officer)
                                   Date:        March 25, 2005

/s/ John J. Holton
---------------------------
John J. Holton                     Director     March 25, 2005

/s/ Kevin Flannery
---------------------------
Kevin Flannery                     Director     March 25, 2005

/s/ Scott Schooley
---------------------------
Scott Schooley                     Director     March 25, 2005

/s/ Michael Scinto
---------------------------
Michael Scinto                     Director     March 25, 2005

/s/ Ralph J. Takala
---------------------------
Ralph J. Takala                    Director     March 25, 2005

/s/ Lynn Tilton
---------------------------
Lynn Tilton                        Director     March 25, 2005




                                       60

<PAGE>


<TABLE>
<CAPTION>
<S>                                              <C>             <C>                               <C>                <C>

SCHEDULE II

                       SCAN-OPTICS, INC. AND SUBSIDIARIES
                        VALUATION AND QUALIFYING ACCOUNTS
               THREE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
                                   (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
---------------------------------------------- --------------- ---------------- ---------------- ---------------  ----------------

Year ended December 31, 2004
    Allowance for doubtful accounts (billed
    and unbilled)                                $     1,134     $       567                       $   1,463(1)      $    238

Year ended December 31, 2003:
    Allowance for doubtful accounts (billed
    and unbilled)                                $     1,574     $        22                       $     462(1)      $   1,134

Year ended December 31, 2002:
    Allowance for doubtful accounts (billed
    and unbilled)                                $     1,936     $        35                       $     397(1)      $   1,574


(1) Uncollectible accounts written off, net of recoveries.
</TABLE>


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


                                       61

<PAGE>