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, 2002
                    -----------------------------------------
( )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            (I.R.S. Employer Identification Number)
 of incorporation or organization)


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

                                 (860) 645-7878
-------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)


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

Securities registered pursuant to
Section 12(g) of the Act:             Common stock, $.02 par value
                                      ----------------------------
                                             (Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.
                                                       (X) YES ( ) NO

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

Indicate  by check mark  whether  the  registrant  is an  accelerated  filer (as
defined in Exchange Act Rule 126-2)                    (_) 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:
$2,083,125 as of June 30, 2002.

The number of shares of common stock,  $.02 par value,  outstanding  as of March
24, 2003 was 7,439,732.



                                        1
<PAGE>


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

Portions of the definitive Proxy Statement,  relating to the 2003 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


                                       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 provides information capture hardware and software products combined
with lifecycle support and maintenance  services,  which constitute the platform
for its systems  integration and  professional  services  organization to create
information management solutions in response to a customer's business needs.

The Company is a leader in  developing,  applying and  supporting  technology to
solve information  capture and customer service problems for government agencies
and commercial  businesses.  Historically the Company's research and development
activity has focused on  improving  accuracy  and  performance  of the image and
"OCR" (optical  character  recognition)  scanning platforms yielding the premier
scanner in the  industry.  More  recently this effort has grown to encompass the
expansion and  enhancement of the software  suites that surround these versatile
scanner  platforms.  Acquired and  developed  expertise  in  database,  storage,
network and  Microsoft  development  environments  have  enhanced the  Company's
strength in developing and supporting complex system integration projects. Still
focused on the information capture portion of system  architecture,  the Company
has built a comprehensive  development and support infrastructure.  The range of
these  solutions  has  expanded to include data  capture,  data  perfection  and
archival solutions,  adding value to the information available for our customers
to better serve their customers and manage their business.

The Company's  strategy is to provide  information  capture  solutions to select
vertical  markets.   With  demonstrated   success  in,  government,   insurance,
assessment, transportation, order fulfillment and financial markets, the Company
has chosen to focus on and serve these industries.

The  Company  has three  distinct  divisions:  Solutions  and  Products,  Access
Services and  Manufacturing  Services.  These divisions are established to focus
the  Company's  resources and assets in a  cost-effective  manner on the clients
that it serves.  Although each division 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  Solutions and Products  Division  combines  technology  with its
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.  The Company's ability
to offer  customized and integrated  system  solutions has helped  customers all
over the world to meet their productivity and profitability objectives.

The Access Services Division of the Company provides third party and proprietary
product maintenance  services  nationwide,  as well as in the UK and Canada. The
Company has been selected by over 18 companies to provide  maintenance  services
for  their  products  at the  customer  site  or  through  the  Company's  depot



                                       3
<PAGE>

maintenance facility. In support of its many third-party contracts,  the Company
has  implemented  a logistics  and  dispatch  center  that is being  utilized in
support  of  several  high  volume,  low  cost  products.  This  business  model
demonstrates  the flexibility of the Company to provide  customized  services to
meet  customer  needs,  versus having the customer  adapt to Company's  business
model. Like the rest of the Company this division depends on its ISO9001 quality
processes to assure high levels of customer satisfaction.

The Manufacturing  Services Division manufactures the Company's high performance
proprietary  scanning  platforms.  Due to its  ability to deliver  high  quality
products,  this  division  is able to  attract  several  contract  manufacturing
customers.  Recently it supplemented its ISO9001  certification with initial FDA
registration  that  authorizes  the Company to  manufacture  medical  diagnostic
imaging equipment. This division is also establishing an outsourcing capability,
Business  Process  Outsourcing  ("BPO"),  which  is a  service  to  image-enable
documents for  subsequent  document  management,  storage and  retrieval.  These
services provide a low-risk, cost-effective solution for customers with document
imaging needs and will follow the  disciplined  process for quality control that
have served the division in the past.


SOLUTIONS AND PRODUCTS DIVISION

Solutions
Focused on the needs of the client,  the Company  follows an ISO9001  documented
process to define the customer  requirements  prior to  proposing a  value-based
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.  Because of its  investment in the skills and expertise of
its development organization,  the Company is well positioned to deliver quality
solutions in a timely  manner.  This  capability is further  enhanced by over 33
years of experience serving specific target markets.

Target Markets
The Company has six defined target markets that are a focus for its go-to-market
strategy.  The following describe these markets:
o Government - federal,  state and local tax  processing, licensing and labor
               reporting
o Insurance - medical claims and enrollments
o Assessment - test scoring
o Transportation  - proof of delivery and 3rd party billing accounting
o Order Fulfillment - subscription and order processing
o Financial - proxy balloting and real estate taxes

Scan-Optics Technology
The  Company  has  continually   been  on  the  leading  edge  of  technological
developments  in the  OCR,  "ICR"  (intelligent  character  recognition),  "OMR"
(optical mark read) and Imaging arena. Our most recent developments have yielded
a patent application for gray scale OMR recognition for assessment  applications
and software  based  endorsement  of images and a patent for  "detecting  double
documents" using acoustic sensors.


                                       4
<PAGE>


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
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 has the  capacity to import and index  thousands of documents
per hour in industry standard TIFF format.

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

Scan-Optics'  PayWise, is a turnkey solution designed to increase the efficiency
of an  Accounts  Payable  department  by  integrating  image  processing  of the
supplier  invoice to a  company's'  Accounts  Payable  system.  The  Company has
implemented  this  product  in  its  own  SAP  accounts  payable  function  with
significant cost and efficiency savings.

TIS eFLOW, comes to the Company through a cooperative  marketing  agreement with
Top Image  Systems,  Ltd. and provides forms  processing in both  structured and
unstructured environments.

TIS eMobilis,  comes to the Company through a marketing agreement with Top Image
Systems,  Ltd. and provides electronic data entry via electronic devices such as
personal digital assistants (PDA's).

Mitek,  is a character  recognition  engine that has been  integrated  into many
Scan-Optics solutions.

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.


                                       5
<PAGE>


Hardware Products
Scan-Optics'  Series 9000M and the Series 9000mm image scanners  feature modular
design,  advanced  digital  camera  technology,  with black and white,  color or
grayscale output. Both scanners are based on Windows 2000 operating environment,
and can process  intermixed  forms of varying  sizes and  weights,  and both are
available  as simplex or  duplex,  with an  integrated  image  quality  monitor,
acoustic  double-detect  feeder,  and character  recognition  rates up to 10,000
characters per second.

Scan-Optics'  Series 8000 image only scanner is targeted at the mid-range market
for production scanning.  Rated at 200 pages per minute, the Series 8000 scanner
family  converts large volumes of documents into  compressed  industry  standard
electronic images.

In 2003, the Company intends to continue its aggressive  program of research and
development enhancements of additional options and capabilities for its existing
products as well as the  development  of new products that utilize the advantage
of the  Company's  core  competencies.  The  Company  will  continue  to develop
relationships with other technology  companies to provide technology outside its
product  suite to be  implemented  through the  Company's  integration  services
organization to meet customer requirements.

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


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

  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


                                       6
<PAGE>


The  Company  has  provided  software  solutions  to its  customers  since 1968.
Utilizing Company developed products and third-party products,  the professional
services group  provides  turn-key  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 provided through the professional  services offered
by the Company. The Company also provides  individual,  custom software services
as requested by the  customer.  In this way, the Company can either  provide the
entire  solution of hardware and software  with support or simply  provide those
specific services that the customer desires.

Customer Satisfaction

Expansion  of this  business  has  been  possible  with the  excellent  customer
relationships that we enjoy. 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 report customer  satisfaction
levels in various surveys conducted throughout the year. The surveys also follow
a  documented  quality  process  within  our  ISO9001   certification   program.
Management  meets weekly to assure the proper  attention is focused on the needs
of our customers.

Value-Added Engineering Services and Solutions
The  Company has been  supplying  engineering  services  and  solutions  to meet
customer needs since  introducing its first fully  integrated  solution in 1976.
The  solutions  include  scanning,  recognition,   Key-From-Image,  data  entry,
archival  storage and  retrieval,  and  communications.  The following are three
examples of the capabilities of the Company's engineering services organization:

o     During  1993,  the Company was  selected to develop a prototype  system to
      process medical claims for a healthcare  agency in Japan.  This system was
      designed  with 36  stacker  pockets  for  sorting  forms;  expanded  paper
      handling  capabilities  for  light-weight,  flimsy forms;  high resolution
      image cameras to permit  recognition of complex Japanese kanji characters;
      and  software  forms  recognition  for  up to  20,000  different  document
      formats.

o    The Company has developed special  recognition  techniques to process order
     forms  that  contain  stamps.  These  stamps  are used as an  entry  into a
     sweepstakes  contest or to select  ordered items for a record or book club.
     The stamps are of a  multitude  of colors  and are  successfully  processed
     through the Company's special recognition features. Similar techniques have
     been used to provide quality and fraud control  application for the indicia
     from postal meters.

o    The Company has also developed  recognition  analysis for educational  test
     scoring.  This process is  accomplished  in full duplex mode at a transport
     speed of 50 inches per second.


                                       7
<PAGE>


ACCESS SERVICES DIVISION

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

Maintenance   service  is  provided  through  a  network  of  over  120  service
technicians worldwide.  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 Scan-Optics has developed comprehensive
depot maintenance capability with logistics and call center support. The Company
focuses  on  comprehensive  diagnostic  routines,  modular  designs,  preventive
maintenance  procedures  and  customer  surveys to provide its users high system
availability to perform mission critical applications.

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


MANUFACTURING SERVICES DIVISION

Manufacture of the Company's  products  requires the  fabrication of sheet metal
and mechanical  parts,  the  subassembly of electronic and mechanical  parts and
components,   and   operational  and  quality  control  testing  of  components,
assemblies and completed systems. The Company's products consist of standard and
Company-specified  mechanical and  electronic  parts,  sub-assemblies  and major
components,  including  microcomputers.  A  majority  of  parts  are  purchased,
including many complex electronic and mechanical subassemblies. The Company also
purchases major standard  components,  including low speed scanners,  jukeboxes,
PCs,  printers and servers.  An important aspect of the Company's  manufacturing
activities is its quality  control  program  documented  in the ISO9001  quality
system.   One  of  the  many   methods   to  assure   quality   is  the  use  of
computer-controlled testing equipment.

The Company has not  experienced  significant  shortages  of any  components  or
subassemblies. Alternate sources for such components and subassemblies have been
developed.  Certain  sole source items have been  evaluated  and the Company has
determined  that a minor  engineering  effort  would be  required  to  qualify a
replacement.

The contract manufacturing services function,  within the Manufacturing Services
Division, provides electro-mechanical assembly and test services under contracts
with customers who develop and sell a variety of equipment.


                                       8
<PAGE>


Beginning  with the customer's  plans,  the Company can manage each project from
concept to completion. The capabilities provided include:
         Project Management
         Engineering and Prototyping
         Procurement and Materials Management
         Precision Machining, Sheet metal Fabrication and Welding
         Networks/System Integration
         Systems Testing
         Just-in-Time/Kanban Delivery Systems
         Professional Services and Training
         Worldwide Field Service - through Access Services
         Agency Standards Certification (FCC, UL, CE, CSA, ISO9001)
         Strong Supplier Relationships with:
                  Commercial Painting and Metal Finishing
                  Printed Circuit Board Assemblies and Testing
                  Wire Harness and Cable Assembly and Testing
                  Specialty Packaging
                  Worldwide Shipping

This  division  is also  utilizing  its  manufacturing  process  disciplines  in
structuring an outsourcing  service capability for image capture and data entry.
Although  it is in the early  stages of  development  the Company  believes  the
disciplines that are practiced  everyday in the  manufacturing  process will add
significant  customer value in terms of quality and efficiency to an outsourcing
function.


SIGNIFICANT CUSTOMERS

In 2002 and 2001, no customers  accounted for more than 10% of total revenue. In
2000,  the Company  derived 13% of its total  revenue  from one  customer,  Toyo
Officemation, Inc., one of the Company's distributors in Japan.


CHANNELS OF DISTRIBUTION

The  Company  sells  directly  to  end-users  and  integrators  in the  USA  and
distributors internationally.


QUALITY

All  aspects of the  Company's  business  fall under the  ISO9001  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.


                                       9
<PAGE>


BACKLOG

The backlog for the Company's  products and services as of December 31, 2002 was
approximately   $18.7  million.  As  of  December  31,  2001,  the  backlog  was
approximately  $22.5  million.  Backlog as of March 19,  2003 was  approximately
$24.9 million.  The backlog  consists of equipment,  software and services to be
sold and  non-cancelable  rentals and  maintenance  due on  existing  rental and
maintenance contracts over the next year. The Company normally delivers a system
within 30 to 180 days after  receiving  an order,  depending  upon the degree of
professional services and software customization required.


COMPETITION

The Company's  Solutions and Products  Division  competes with software  service
providers who integrate systems with products from multiple vendors. The Company
differentiates  its  solutions  by  offering  a  total  system,  including  post
installation support of hardware and software services along with image scanning
and  document  handling  transports  under the defined  processes in the ISO9001
quality manual.  The Division focuses on industry specific  "application"  areas
with solutions  utilizing image and data entry/data  capture systems provided by
the Company and implemented under strictly defined quality processes.

A large portion of the revenue generated by the Access Services Division is from
post installation hardware and software services on integrated systems installed
by the Company's Solutions and Products Division.  Due to the proprietary nature
of these  integrated  systems,  this division faces little  competition for this
business.   The   remaining   revenue  is  generated  by  the  field  repair  of
electro-mechanical  devices manufactured by third-party equipment manufacturers,
primarily  of scanner  products,  that do not have  their 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  quality process manual and its 33 years of
experience in providing scanner repair in this market.

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


                                       10
<PAGE>


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;
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 continue our  transition  to  ISO9001:2000.  The Company  expects to
complete the transition process and obtain ISO9001:2000 certification by October
2003.


PATENTS

The Company  currently has nine United  States  patents in force and one pending
which  expire  between  2003 and 2022.  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.


                                       11
<PAGE>


EMPLOYEES

As of December  31,  2002 the Company  employed  192 people,  including  17 with
administrative responsibilities,  22 in marketing and sales, 101 in software and
service activities,  14 in engineering and 38 in manufacturing  capacities.  The
Company  considers  its  employee  relations  to be good.  The  Company  has not
experienced any work stoppages.


FUNDED DEVELOPMENT AGREEMENTS

During  2002,  2001 and 2000,  the Company  completed  a number of small  custom
development   contracts   for  specific   customers   resulting  in  revenue  of
approximately  $43,000,  $110,000 and  $200,000,  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.


EFFECTS OF ENVIRONMENTAL LAWS

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



                                       12
<PAGE>


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)                                                 2002                2001          2000
-------------------------------------------------------------------------------------------------------

Revenues
<S>                                                         <C>       <C>               <C>
  Solutions and products                           $        16,376    $        16,667   $       23,295
  Access services                                           11,499             13,193           12,669
  Contract manufacturing services                            1,466                880            2,338
                                                      -------------------------------------------------
    Total revenues                                          29,341             30,740           38,302

Cost of solutions and products                              10,715             13,298           22,806
Service expenses                                             8,539             11,200           11,287
                                                      -------------------------------------------------

    Gross profit margin                                     10,087              6,242            4,209

  Operating expenses, net                                    9,175             12,522           21,918

                                                      -------------------------------------------------
Income (loss) before income taxes                  $          912     $        (6,280)  $      (17,709)
                                                      =================================================

Total assets                                       $        26,406    $        27,380   $       36,513

Total  expenditures  for  additions to
long-lived assets                                  $            79    $           121   $          109

</TABLE>


Certain 2001 and 2000 amounts have been  reclassified  to conform to the current
year presentation.

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.

Note:  In 2002 and  2001,  no  customers  accounted  for more  than 10% of total
revenue.  In  2000,  the  Company  derived  13% of its  total  revenue  from one
customer, Toyo Officemation, Inc., one of the Company's distributors in Japan.


                                       13
<PAGE>


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.

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

(thousands)                  2002           2001            2000
---------------------------------------------------------------------
Latin America     $      72   24% $       152    3% $     152     2%

Europe                  149   49%       3,706   73%     1,667    22%
Pacific Rim              81   27%       1,220   24%     5,881    76%
                  ---------------------------------------------------
                  $     302       $     5,078       $   7,700
                  ===================================================

Export sales  represented 3%, 45%, and 43% of hardware and software revenues for
the three years ended December 31, 2002, 2001, and 2000, respectively.


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

There are two  lawsuits  currently  pending  against the  Company.  Although the
ultimate  outcome is  uncertain,  based on currently  known  facts,  the Company
believes that it has strong defenses against both lawsuits and the resolution of
these matters will not have a material adverse effect on the Company's financial
position or annual operating results.


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

The Company did not submit any  matters  during the fourth  quarter of 2002 to a
vote of the stockholders.


                                       14
<PAGE>


EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT

Officers of the Company are set forth in the schedule below.
                                                                     Officer
Name                   Age     Principal Occupation:                  Since
-----------------------------------------------------------------------------

James C. Mavel         57      Chairman, Chief Executive Officer
                               and President                          1996

Joseph P. Crouch       40      Vice President -
                               Manufacturing Services Division        1999

Richard C. Goyette     51      Vice President -
                               Sales and Marketing                    1996

Richard D. Harris      42      Corporate Secretary                    2001

Joel K. Howser         55      Vice President -
                               Software Development                   1998

Clarence W. Rife       63      Vice President -
                               Access Services Division and
                               Hardware Engineering                   1975

Michael J. Villano     43      Chief Financial Officer, Vice
                               President and Treasurer                1992

Alan W. Ware           64      Vice President -
                               Project and System Integration         2000



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


                                       15
<PAGE>


Mr. Crouch joined the Company in March 1999 and was 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. Rife has been  employed by the Company  since 1969 and was  appointed to the
position of Vice  President  in 1975.  He is currently  Vice  President - Access
Services Division and Hardware Engineering.

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

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

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


                                       16
<PAGE>


                                     PART II


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


COMMON STOCK MARKET PRICES AND DIVIDENDS

The following is a two-year history of Common Stock prices for each quarter. The
table sets forth the high and low closing  quotations  per share for the periods
indicated  of  the  Common  Stock  in the  over-the-counter  market  based  upon
information  provided by the National  Association of Securities  Dealers,  Inc.
Effective November 10, 2000 the Company was notified by The NASDAQ Stock Market,
Inc. that its common stock would begin listing on the Over the Counter  Bulletin
Board.  This action was taken  because of the  inability  to maintain the $1 per
share bid price  requirement  for continued  listing on the NASDAQ Stock Market.
The  closing  quotations  represent  prices  between  dealers and do not include
retail  markups,   markdowns  or  commissions  and  may  not  represent   actual
transactions. There were 912 stockholders of record at December 31, 2002.

<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>
2002             $  .41       $  .22       $  .38       $  .26         $  .39      $  .25      $  .40     $  .25
2001             $  .33       $  .14       $  .35       $  .21         $  .93      $  .27      $  .35     $  .20

</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.



                                       17
<PAGE>
ITEM 6 - SELECTED FINANCIAL DATA
--------------------------------


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

SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
(thousands, except share data)                  2002             2001               2000              1999               1998
------------------------------------------------------------------------------------------------------------------------------------

<S>                                            <C>           <C>                 <C>                <C>                <C>
Total Revenues                                 $ 29,341      $  30,740           $  38,302          $ 51,992           $ 53,971
                                             =======================================================================================

Income (loss) before income taxes                   912         (6,280)            (17,709)            (8,415)            3,234
Income taxes (benefit)                               81             33                  61              (240)             1,105
                                             ---------------------------------------------------------------------------------------

Net Income (Loss)                                  $831       $ (6,313)          $ (17,770)          $(8,175)           $ 2,129
                                             =======================================================================================

Basic earnings (loss) per share                     .12           (.90)              (2.53)            (1.17)             0. 31

Basic weighted-average shares                  7,026,232     7,026,232           7,025,064         6,979,651          6,921,331

Diluted earnings (loss) per share                    .11          (.90)              (2.53)            (1.17)              0.30
Diluted weighted-average shares                7,317,437     7,026,232           7,025,064         6,979,651          7,102,658



SELECTED BALANCE SHEET DATA


Total assets                                      26,406        27,380              36,513            56,792             54,301
Working capital (deficit)                          5,283         4,184              (9,833)            4,727             15,107
Long Term Obigations                              10,682        11,397
 Mandatory redeemable preferred stock              3,800         3,800
 Total stockholders' equity                        1,272           360               4,307            22,081             30,246

</TABLE>


The Company has not paid any dividends for the five-year  period ended  December
31, 2002.

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.


                                       18
<PAGE>


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

Outlook
The forward-looking  statements  contained in this Outlook and elsewhere in this
document are based on current  expectations.  Scan-Optics,  Inc. (the "Company")
and its future  operations  are  subject to a number of risks,  including  those
discussed  below. The following list is not intended to be an exhaustive list of
all the risks to which the Company's business is subject,  but only to highlight
certain substantial risks faced by the Company. Although the Company completed a
total  debt  restructuring  effective  December  31,  2001  (see  Note  F to the
consolidated financial statements 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, 2002 of
approximately  $10.5  million by $.1 million.  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.   The   Company's   business   could  be  adversely   affected  by
technological  changes.  The  foregoing  factors  should  not  be  construed  as
exhaustive.

The Company  reported net income for the year of $.8 million or $.11 per diluted
share,  compared to a net loss of $6.3 million,  or $.90 per diluted share,  for
2001.  During the fourth  quarter of 2002, the Company  determined  that certain
amounts  previously  recorded  as  liabilities  were no longer  due or have been
settled for amounts less than previously recorded. This resulted in other income
of $.4 million in the fourth quarter of 2002.  During the third quarter of 2002,
the Company  negotiated a reduction in the final  payment due BlueBird  Systems,
Inc. for the 1999 purchase of the DocWise  source code license which resulted in
a reduction of  previously  recorded  amortization  expense of $.3 million.  The
Company has delivered excellent operational results even though the industry has
been  burdened  with a difficult  economic  environment.  Our efforts to improve
efficiencies  through  quality  control  have paid  significant  benefits to our
customers and our bottom line. We are fully  committed to delivering  successful
solutions by using the quality  standards we have established  under our ISO9001
certification.

The Company has three major initiatives currently underway to develop sources of
revenue growth and increase  profitability.  They are to emphasize the "Business
of Solutions"  focus in targeted  markets,  introduction  of a Business  Process
Outsourcing  Service,  and expansion of the Access Services  Division to include
enterprise wide maintenance  services.  A fourth initiative that is currently on
hold is to add long term value through the acquisition of key strategic products
or enterprises.  The inability of the Company to carry out these initiatives may
have a material adverse effect on revenue growth and earnings.

The  first  initiative  is to  provide  cost  effective  solutions  through  the
Company's  development of target market data capture applications  combined with
its high speed transports and archival systems. The Company has refined its


                                       19
<PAGE>


target  market  approach  and has  chosen  to  place  its  primary  focus on the
government   and   insurance   markets,   while   continuing   to  address   the
transportation, assessment, financial and order fulfillment markets. The Company
expects to continue to  emphasize  its  "Business of  Solutions"  focus on these
targeted  markets for the  foreseeable  future.  As other  market  opportunities
emerge,  the Company  will  evaluate  the  potential  of using its  products and
services to provide solutions in these new markets. The Company's revenue in the
solutions  initiative  increased  $1.8  million  from 2001 to 2002 mainly in the
assessment market.

The  second  initiative,  introduced  in  early  2003,  is  a  Business  Process
Outsourcing  ("BPO") Service to image-enable  documents for subsequent  document
management,  storage and retrieval.  The  Company's' new BPO Services  provide a
low-risk,  cost-effective solution for customers with document imaging needs. As
increasing  numbers of both  government  and  commercial  clients  migrate  from
paper-based filing systems to state-of-the-art image-based storage and retrieval
systems,  they are faced with the need to convert their  existing paper files or
opt to outsource the activity to a proven  solution  provider.  The BPO services
offer customers a high quality, ISO9001 certified,  turnkey outsourcing solution
utilizing the Company's proprietary hardware technology,  and further leveraging
software skills, resources and process controls.

The third initiative,  recently announced by our Access Services Division, is an
expansion to include  enterprise wide maintenance  services.  Leveraging off the
experience  it has  gained  through  its many  third  party  agreements,  Access
Services is well positioned to expand maintenance coverage and provide customers
with "one number to call" for maintenance  services  regardless of the equipment
manufacturer.  Through the  division's  120  technical  service  representatives
strategically  located  throughout  the US,  the  Company  believes  that it can
provide high quality,  cost  effective  enterprise  maintenance  to its existing
customer base as well as new accounts.

While the Company is principally  focused on improving the  profitability of 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.


                                       20
<PAGE>


RESULTS OF OPERATIONS - 2002 VS. 2001

Total revenues decreased $1.4 million or 5% from 2001 to 2002.

Hardware and software  revenue  increased $.1 million or 1% from the prior year.
North American sales increased $4.9 million or 80% due mainly to the replacement
of obsolete  Series 9000 systems that were at least seven years old and were not
capable  of  being  maintained  due to the  lack of  parts  availability.  Total
international sales decreased $4.8 million or 94% from 2001. International sales
in  the  Pacific  Rim  decreased  93% or  $1.1  million  due to the  significant
reduction  of spare  parts  orders and  scanner  systems  sold to the  Company's
distributor  in Japan.  Sales to Europe  decreased  $3.6 million or 96% due to a
large  integrated  solution sale to the British  government that was recorded in
2001. Latin American sales remained consistent with the prior year mainly due to
the continued decline in economic conditions in the Latin American countries.

Professional  services  revenue  increased  $.2  million or 3% from 2001 to 2002
mainly due to the increase in hardware and software revenue.

Access  services  revenue  decreased  $1.7  million or 13% from 2001 to 2002 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.

Cost of hardware and software  revenue  decreased $1.5 million or 16% from 2001.
Cost of hardware  and  software  revenue as a  percentage  of revenue was 69% in
2002, as compared to 83% in 2001. The decrease is mainly due to the  improvement
in gross  margins  related  to the sales  mix.  In 2002,  the  Company  recorded
approximately  three  times the number of Series  9000  scanners  as compared to
2001,  which  accounted  for more  revenue and  increased  margins.  In 2001,  a
significant  portion of the  revenue  was made up of  third-party  products  and
distributor sales of Series 8000 scanners, which yield lower margins than Series
9000 scanners.

Cost of  professional  services  revenue  decreased  $1.1 million or 27% in 2002
compared  to the prior year  mainly due to  decreases  in  salaries  and related
expenses of $.3 million,  contractor expenses of $.5 million, travel expenses of
$.1 million and other  expenses of $.2 million.  Cost of  professional  services
revenue as a percentage of revenue was 44% in 2002, as compared to 62% in 2001.

Cost of Access services revenue decreased $2.7 million or 24% from 2001 to 2002.
The decrease is mainly due to a decrease in goodwill amortization expense of $.8
million,  a decrease  in UK  operating  expense of $.7 million and a decrease in
salaries and related expenses of $.6 million. Cost of Access services revenue as
a percentage of revenue was 74% in 2002, as compared to 85% in 2001.


                                       21
<PAGE>


Sales and marketing  expenses  decreased $.6 million or 16% from 2001 mainly due
to a decrease in UK operations.

Research and development expenses decreased $1.1 million or 39% from 2001 mainly
due  to a  decrease  in  salaries  and  related  expenses  of  $.6  million  and
amortization of the software license agreement of $.5 million in 2001.

General and administrative expenses decreased $.2 million or 6% from 2001 mainly
due to decrease  in  goodwill  amortization  expense of $.5  million,  and a $.2
million  decrease in legal and accounting  fees,  offset by the recording of the
settlement of the Southern  Computer  Systems  stock  purchase  agreement  which
forgave $.5 million due under the consulting and non-compete retainer in 2001.

Interest  expense  decreased  $.9  million  from  2001 due to the  $6.5  million
reduction  in  the  Company's   outstanding   debt  as  a  result  of  the  debt
restructuring  that was effective December 31, 2001, as well as the reduction in
the prime rate that  occurred in 2002.  The weighted  average  interest rate was
5.5% in 2002 compared to 9.8% in 2001.

Other  Income  increased  $.4 million due to the  reduction  of certain  amounts
previously  recorded as liabilities that were no longer due or have been settled
for amounts less than previously recorded.


RESULTS OF OPERATIONS - 2001 VS. 2000

Total revenues decreased $7.6 million or 20% from 2000 to 2001.

Hardware and software revenue decreased $6.9 million or 38% from the prior year.
North  American  sales  decreased  $4.3 million or 41% due mainly to the concern
over the  expiration  on July 1,  2001  and  potential  non-renewal  of the bank
agreement as well as the general  economic  environment  for goods and services.
Total international sales decreased $2.6 million or 34% from 2000. International
sales in the Pacific Rim  decreased  79% or $4.6 million due to the  significant
reduction  of spare parts orders and scanner  systems  sold to Japan's  National
Ministry of Health.  Sales to Europe increased $2 million or 122% due to a large
integrated  solution  sale  to the  British  government,  Latin  American  sales
remained  consistent with the prior year mainly due to the continued  decline in
economic conditions in the Latin American countries.

Professional  services  revenue  decreased $1.2 million or 16% from 2000 to 2001
mainly due to the  completion  of various  contracts  during  2001 that were not
completed during 2000 and the slowdown in orders as noted above.

Access services revenue increased $.5 million or 4% from 2000 to 2001 due mainly
to an  increase  in new third  party  maintenance  contracts  and the  increased
retention of existing customers using Scan-Optics manufactured equipment.


                                       22
<PAGE>


Cost of hardware and software  revenue  decreased $5.4 million or 36% from 2000.
This  decrease is mainly due to the decline in hardware  and  software  revenue.
Cost of hardware  and  software  revenue as a  percentage  of revenue was 83% in
2001, as compared to 81% in 2000.

Cost of  professional  services  revenue  decreased  $4.2 million or 51% in 2001
compared  to the prior  year  mainly due to a decrease  in  contractor  expense,
salaries and related benefits and travel expense.  Cost of professional services
revenue as a percentage of revenue was 62% in 2001, as compared to 108% in 2000.

Cost of Access services revenue  remained  consistent from 2000 to 2001. Cost of
Access services  revenue as a percentage of revenue was 85% in 2001, as compared
to 89% in 2000.

Sales and marketing expenses decreased $2 million or 34% from 2000 mainly due to
a decrease in salaries,  commissions and related benefits,  travel expense and a
provision for uncollectable accounts receivable.

Research and development  expenses decreased $.8 million or 21% from 2000 mainly
due to a decrease in consulting expense and salaries and related benefits.

General and administrative expenses decreased $6 million or 60% from 2000 mainly
due to the accounts  receivable  allowance recorded during the fourth quarter of
2000 for various accounts that were determined to be uncollectable which was not
required in 2001 and the recording of the  settlement  of the Southern  Computer
Systems  stock  purchase  agreement  which  forgave  $.5  million  due under the
consulting and non-compete retainer. (See Note C.)

Interest  expense  decreased $.6 million from 2000 due mainly to a change in the
interest  rate on the Company's  indebtedness.  Both the line of credit and term
loan  carried an  interest  rate of prime  through  March 24, 2000 when the rate
increased to prime plus 5%. As of January 30, 2001 the interest rate was reduced
to prime plus 2%. The weighted  average  interest rate was 9.8% in 2001 compared
to 13.2% in 2000.



LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents decreased $1.4 million from 2001 to 2002 mainly due to
the paydown of the revolving line of credit.

At December 31, 2002, the Company had $10.5 million in  outstanding  borrowings,
with $1.5  million  classified  as current,  against  its $12 million  available
borrowings. The Company anticipates meeting its current obligations and resource
needs through the funds generated from operations.  The average  borrowing level
for 2002 was $10.7 million  compared to $18.3 million for 2001.  The decrease is
due to the debt  restructuring that was effective December 31, 2001 (See Note F)
and  payments of portions of the  outstanding  debt from cash flow  generated in
2002.


                                       23
<PAGE>


Effective  December 31, 2001, the Company  restructured its loan agreements with
Patriarch  Partners,  LLC.  ("Patriarch"),  which  resulted in  forgiveness of a
portion of outstanding term debt,  additional  borrowing capability in the short
term and reduced  interest  expense due to reduced debt levels.  In exchange for
the  forgiveness  of debt,  the Company  issued  shares of  preferred  stock and
warrants to purchase  common stock.  The debt agreement  expires on December 31,
2004. The Company  believes that the  restructuring  will allow execution of the
Company's  business  plan  through the term of the debt  agreement.  The Company
currently  anticipates  that it will be able to renew or refinance its long term
debt at maturity in December 2004,  although there can be no assurance as to the
availability  or terms of such  financing.  The loan  agreement  with  Patriarch
contains covenants which, among other things, require the maintenance of minimum
earnings  before  interest and taxes,  depreciation  and  amortization,  capital
expenditure spending limits, accounts receivable write-offs and backlog levels.
(See Note F.)


The following summarizes the Company's significant  contractual  obligations and
commitments that impact its liquidity as of December 31, 2002.

<TABLE>
<CAPTION>

Contractual Obligations                                    Payments Due by Period
-------------------------------------------------------------------------------------------------------------------
(thousands)                                              Less than 1          1- 3          4 - 5        After 5
                                              Total         year             Years         Years          years
-------------------------------------------------------------------------------------------------------------------
<S>                                            <C>            <C>           <C>
Notes payable                                  $ 10,542       $ 1,500       $ 9,042
Interest payable                                    407                         407
Executive insurance agreement                       408                          50        $  100        $  258
Capital leases                                      361            74           222            65
Operating leases                                  2,337           646         1,327           104           260
-------------------------------------------------------------------------------------------------------------------
Total contractual cash obligations             $ 14,055      $  2,220      $ 11,048        $  269        $  518
-------------------------------------------------------------------------------------------------------------------
</TABLE>


Operating  activities used $.2 million of cash in 2002 compared to providing $.9
million in 2001.  The non-cash  expenses in 2002 were $2.5  million  compared to
$5.1 million in 2001. The non-cash items relate to  depreciation of fixed assets
which is discussed in net plant and equipment  below,  amortization  of customer
service inventory and software license, amortization of goodwill, provisions for
losses  on  accounts  receivable,  provisions  for  inventory  obsolescence  and
non-cash income from a reversal of previously  recorded  liabilities.  These and
other components of operating activities are discussed below.

Net accounts  receivable  and unbilled  receivables  increased  $.6 million from
December  31,  2001.  The  increase  is mainly  related to the  slowdown  in the
economy,  which the Company  believes has caused many companies to extend beyond
their traditional payment timeframes.

Total  inventories  increased  $.6  million  from  2001  levels.   Manufacturing
inventories  increased  $.8  million  during  the  year  due to an  increase  in
materials and component  parts of $1.2 million which was offset by a decrease in
work-in-process  and finished  goods  inventory of $.4 million.  The increase in
materials  and  component  parts is mainly due to an increase in the  production
schedule for the first quarter of 2003. The manufacturing inventory increase was
offset by a decrease in customer  service  inventory of $.2  million,  which was
mainly attributable to the amortization of spare parts inventory.


                                       24
<PAGE>


Net plant and equipment  decreased $.1 million in 2002.  This decrease is due to
depreciation  of $.4  million  which  was  offset by new  capital  leases of $.3
million.

Software license decreased by $.6 million due to amortization of the source code
license  recorded  during the year of $.3  million and a  negotiated  settlement
which reduced the final payment due of $.3 million.

Goodwill  decreased  by $.2  million  in 2002 due to the  reduction  of  certain
amounts previously  recorded as liabilities that were no longer due or have been
settled for amounts less than previously recorded.  The amortization of goodwill
was eliminated as of January 1, 2002 due to the issuance of Financial Accounting
Standards Board Statements of Financial  Accounting  Standards No. 142 "Goodwill
and Other Intangibles".

Accounts payable  decreased $1 million from December 31, 2001 due to the control
of expenses and the timing of payments along with a $.6 million  decrease due to
the  reduction  of certain  amounts  recorded as accounts  payable  that were no
longer due or have been settled for amounts less than previously recorded.

Notes  payable  to bank  decreased  $1.4  million  due to pay down of the  notes
payable during the year. (See Note F.)

Salaries and wages  decreased  $.4 million from 2001 mainly due to a $.2 million
decrease in accrued commissions,  a $.1 million decrease in bonus accrual, and a
$.1 million decrease in accrued vacation.

Deferred revenue increased $.1 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.

Customer  deposits  increased  $.8 million  due mainly to two large  orders that
contained deposit requirements as part of the contract.

Other  current  liabilities  decreased  $.7  million due mainly to a decrease in
legal and accounting fees of $.2 million, a decrease in accrued health and other
employee related  insurance of $.1 million,  a decrease of $. 3 million due to a
negotiated  reduction in the final  payment due BlueBird  Systems,  Inc. for the
1999 purchase of the DocWise source code license.

Other long term  liabilities  increased  $.6 million  mainly due to accruals for
lease  payments  that were deferred as part of the debt  restructuring  and will
mature on December 31, 2004,  and accrued  interest on the mandatory  redeemable
preferred stock and a new capital lease.


                                       25
<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 to the
Company's   consolidated  results  of  operations  and  consolidated   financial
position.

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 estimation  about the effect of matters that are  inherently
uncertain.  Specific risks for these critical  accounting policies are described
in the following paragraphs.

Revenue  recognition - percentage of completion:  The Company recognizes revenue
and  profit  on  professional  services  engagements  using  the  percentage  of
completion  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.


                                       26
<PAGE>


Inventories - slow moving and obsolete:  The Company performs regular reviews of
excess and obsolete  manufacturing  inventories  to  determine if the  inventory
reserve  recorded on the  balance  sheet is 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.


Long-lived  assets:  The Company  records  impairment  losses and on  long-lived
assets used in operations when events and circumstances indicate that the assets
might be impaired and the  undiscounted  cash flows estimated to be generated by
those  assets are less than net book  value.  The  Company  also  evaluates  the
amortization  periods  of  longlived  assets,  to  determine  whether  events or
circumstances  warrant revised  estimates of useful lives. If the business plans
the Company utilized to calculate the undiscounted  cash flows are not achieved,
a potential  impairment  could exist and a  write-down  of the net book value of
long-lived assets could be required.

Goodwill:  Goodwill  consists  of the  excess  of cost  over the  fair  value of
identifiable  net  assets  of  businesses  acquired  and  were  amortized  on  a
straight-line  basis  over five to twenty  years.  Beginning  January  1,  2002,
goodwill is no longer  amortized,  but is be tested on at least an annual  basis
for impairment, see Note C.


                                       27
<PAGE>



ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
--------------------------------------------------------------------

In 2001,  the  Company  completed  a total  debt  restructuring  (see Note F 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, 2002 of approximately  $10.5 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  Outlook  section  of  Management's  Discussion  and  Analysis  of
Consolidated Financial Condition and Results of Operations, and to Note A of the
Notes to Consolidated Financial Statements.



                                       28
<PAGE>


              ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
              ----------------------------------------------------




                                       29
<PAGE>


                         REPORT OF INDEPENDENT AUDITORS
                         ------------------------------

Stockholders and Board of Directors
Scan-Optics, Inc.

We have audited the  accompanying  consolidated  balance sheets of  Scan-Optics,
Inc.  and  subsidiaries  as of  December  31,  2002 and  2001,  and the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years in the period ended  December 31, 2002.  Our audits also
included the  financial  statement  schedule  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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Scan-Optics,  Inc.  and  subsidiaries  at December  31,  2002 and 2001,  and the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles  generally accepted in the United States.  Also, in our opinion,  the
related financial statement  schedule,  when considered in relation to the basic
financial statements taken as a whole,  presents fairly in all material respects
the information set forth therein.


                                                       /s/ Ernst & Young LLP

Hartford, Connecticut
March 18, 2003


                                       30
<PAGE>


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

<TABLE>
<CAPTION>

                                                                                        December 31
(thousands, except share data)                                             2002                              2001
-------------------------------------------------------------------------------------------------------------------------

Assets
Current Assets:
<S>                                                                <C>                               <C>
  Cash and cash equivalents                                        $               274               $             1,662
  Accounts receivable less allowance of $1,574 in 2002
         and $1,936 in 2001                                                      5,554                             4,353
  Unbilled receivables - contracts in progress                                     377                               945
  Inventories                                                                    9,139                             8,543
  Prepaid expenses and other                                                       591                               504
                                                                 --------------------------------------------------------
    Total current assets                                                        15,935                            16,007


Plant and Equipment:
  Equipment                                                                      8,836                            13,340
  Leasehold improvements                                                         5,209                             5,232
  Office furniture and fixtures                                                    725                             1,338
                                                                 --------------------------------------------------------
                                                                                14,770                            19,910
  Less allowances for depreciation and amortization                             13,456                            18,530
                                                                 --------------------------------------------------------
                                                                                 1,314                             1,380

Software license, net of accumulated amortization
  of $2,140 in 2002 and  $1,773 in 2001                                                                              627
Goodwill                                                                         9,040                             9,249
Other assets                                                                       117                               117
                                                                 --------------------------------------------------------

Total Assets                                                       $            26,406               $            27,380
                                                                 ========================================================


</TABLE>


                                       31
<PAGE>

<TABLE>
<CAPTION>


                                                                                        December 31
(thousands, except share data)                                                  2002                    2001
---------------------------------------------------------------------------------------------------------------

Liabilities and Stockholders' Equity
Current liabilities:
<S>                                                                <C>                     <C>
  Accounts payable                                                 $            2,454      $            3,462
  Note payable                                                                  1,500                   1,500
  Salaries and wages                                                              958                   1,380
  Taxes other than income taxes                                                   501                     524
  Income taxes                                                                     45                       5
  Deferred revenue                                                              2,217                   2,101
  Customer deposits                                                             1,308                     507
  Other                                                                         1,669                   2,344
                                                                  ---------------------------------------------
    Total current liabilities                                                  10,652                  11,823

  Notes payable                                                                 9,042                  10,392
  Other liabilities                                                             1,640                   1,005

  Mandatory redeemable preferred stock, par value $.02
    per share, authorized 3,800,000 shares;
      3,800,000 issued and outstanding                                          3,800                   3,800

Stockholders' Equity
  Preferred stock, par value $.02 per share, authorized
    1,200,000 shares; none issued or outstanding
  Common stock, par value $.02 per share,
    authorized 15,000,000 shares; issued 7,439,732
      shares in 2002 and 2001                                                     149                     149
  Common stock Class A Convertible, par
      value $.02 per share, authorized 3,000,000
        shares; available for issuance 2,145,536 shares;
        none issued or outstanding
  Capital in excess of par value                                               38,354                  38,354
  Accumulated Retained-earnings deficit                                       (33,667)                (34,498)
  Accumulated other comprehensive loss                                           (918)                   (999)
                                                                  ---------------------------------------------
                                                                                3,918                   3,006
  Less cost of common stock in treasury,
    413,500 shares                                                              2,646                   2,646
                                                                  ---------------------------------------------
      Total stockholders' equity                                                1,272                     360
                                                                  ---------------------------------------------
  Total Liabilities and Stockholders' Equity                       $           26,406      $           27,380
                                                                  =============================================
</TABLE>

See accompanying notes.


                                       32
<PAGE>


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

<TABLE>
<CAPTION>

                                                                                      Year Ended December 31
(thousands, except share data)                                               2002               2001                   2000
----------------------------------------------------------------------------------------------------------------------------

Revenues
<S>                                                             <C>                 <C>                 <C>
  Hardware and software                                         $          11,292   $         11,195    $            18,099
  Professional services                                                     6,550              6,352                  7,534
  Access services                                                          11,499             13,193                 12,669
                                                              --------------------------------------------------------------
    Total revenues                                                         29,341             30,740                 38,302

Costs of Revenue
  Hardware and software                                                     7,816              9,331                 14,685
  Professional services                                                     2,899              3,967                  8,121
  Access services                                                           8,539             11,200                 11,287
                                                              --------------------------------------------------------------
    Total costs of revenues                                                19,254             24,498                 34,093

      Gross Margin                                                         10,087              6,242                  4,209

Operating Expenses
  Sales and marketing                                                       3,273              3,914                  5,909
  Research and development                                                  1,798              2,936                  3,720
  General and administrative                                                3,677              3,899                  9,867
  Interest                                                                    846              1,788                  2,393
                                                              --------------------------------------------------------------
    Total costs and expenses                                                9,594             12,537                 21,889
                                                              --------------------------------------------------------------

Operating income (loss)                                                       493             (6,295)               (17,680)


Other income (loss), net                                                      419                15                     (29)
                                                              --------------------------------------------------------------
Income (loss) before income taxes                                             912            (6,280)                (17,709)

  Income tax expense                                                           81                33                      61
                                                              --------------------------------------------------------------

Net  Income (Loss)                                              $             831   $        (6,313)    $          (17,770)
                                                              ==============================================================

Basic earnings (loss) per share                                 $             .12   $          (.90)    $            (2.53)
                                                              ==============================================================

Basic weighted-average shares                                           7,026,232          7,026,232              7,025,064

Diluted earnings (loss) per share                               $             .11   $          (.90)    $            (2.53)

                                                              ==============================================================
Diluted weighted-average shares                                         7,317,437          7,026,232              7,025,064
See accompanying notes.

</TABLE>

                                       33
<PAGE>



SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                             Accumulated      Accumulated
                                                           Capital in         Retained-          Other
                                      Common Stock         Excess of          Earnings       Comprehensive    Treasury
                                  -------------------      Par Value          Deficit        Income (Loss)      Stock      Total
  (thousands, except share data)  Shares       Amount
-------------------------------- ---------------------- ---------------   --------------- ------------- --------------- -----------

<S>             <C>              <C>                     <C>             <C>               <C>             <C>            <C>
Balance January 1, 2000          7,396,232$      148     $   35,568      $      (10,415)   $      (574)    $   (2,646)    $   22,081

Issuance of common stock
upon exercise of stock options      43,500         1             86                                                               87
Net loss                                                                        (17,770)                                    (17,770)
Currency
   translation
   adjustments                                                                                    (91)                          (91)
                                                                                                                        ------------
Comprehensive loss                                                                                                          (17,861)
-------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------

Balance December 31, 2000        7,439,732$      149         35,654            (28,185)           (665)        (2,646)        4,307

Issuance of common stock
 warrants                                                     2,700                                                           2,700
Net loss                                                                        (6,313)                                      (6,313)
Currency translation
adjustments                                                                                       (334)                        (334)
                                                                                                                        ------------
Comprehensive loss                                                                                                           (6,647)
-------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------

Balance December 31, 2001        7,439,732$      149         38,354            (34,498)           (999)        (2,646)          360

Net income                                                                          831                                         831
Currency translation
adjustments                                                                                         81                           81
                                                                                                                        ------------
Comprehensive income                                                                                                            912
-------------------------------- ---------------------- -------------- ------------------ ------------- --------------- ------------

Balance December 31, 2002        7,439,732$      149     $   38,354      $     (33,667)   $      (918)    $    (2,646)    $    1,272
================================ ====================== ============== ================== ============= =============== ============

See accompanying notes.
</TABLE>


                                       34
<PAGE>


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

                                                                            Year Ended December 31
(thousands)                                                        2002             2001         2000
--------------------------------------------------------------------------------------------------------------
Operating Activities
<S>                                                            <C>             <C>           <C>
  Net income (loss)                                            $    831        $ (6,313)      $(17,770)
  Adjustments to reconcile net income (loss) to net cash
    provided (used) by operating activities:
    Depreciation                                                    425             677            887
    Amortization of customer service inventory and
       Software license                                           2,355           2,886          2,400
    Amortization of goodwill                                                      1,326          1,308
    Provision for losses on accounts receivable                      35                          5,505
    Provision for inventory obsolescence                             50             178          1,064
    Reversal of  previously  recorded  liabilities                 (369)
    Changes in  operating
    assets and liabilities:
      Accounts receivable                                          (668)          6,507          8,032
      Refundable income taxes                                                       124          1,158
      Recoverable income taxes                                                                     740
      Inventories                                                (2,634)         (1,873)        (1,578)
      Prepaid expenses and other                                    (87)            465            537
      Software license                                                                            (174)
      Accounts payable                                             (639)         (2,604)        (2,013)
      Accrued salaries and wages                                   (422)            526           (946)
      Taxes other than income taxes                                 (23)            131           (717)
      Income taxes                                                   40            (116)           121
      Deferred revenue                                              116              24            471
      Customer deposits                                             801            (705)          (141)
      Other                                                          21            (330)           371
                                                                ----------------------------------------------
    Net cash provided (used) by operating activities               (168)            903           (745)

Investing Activities
  Acquisition related settlement                                    209             400
  Proceeds from the sale of plant and equipment                      35                            215
  Purchases of plant and equipment, net                            (114)            (64)          (122)
                                                                ----------------------------------------------
    Net cash provided by investing activities                       130             336             93

Financing Activities
  Proceeds from issuance of common stock                                                            87
  Proceeds from borrowings                                           4,376        3,485         25,686
  Principal payments on borrowings                                  (5,726)      (3,098)       (25,123)
                                                                ----------------------------------------------
    Net cash provided (used) by financing activities                (1,350)         387            650

Increase (decrease) in cash and cash equivalents                    (1,388)       1,626             (2)
Cash and Cash Equivalents at Beginning of Year                       1,662           36             38
                                                                 ---------------------------------------------
Cash and Cash Equivalents at End of Year                            $  274     $  1,662       $     36

                                                                 =============================================
Supplemental Cash Flow Information
Interest paid                                                       $  667     $  1,579       $  2,301
                                                                 =============================================

Income taxes paid                                                   $   44     $     61       $      8
                                                                 =============================================
</TABLE>

See accompanying notes


                                       35
<PAGE>



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


NOTE A - DESCRIPTION OF BUSINESS

The  Company   combines   technology,   experience   and  expertise  to  develop
cost-effective  solutions for applications that include  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 include (1) the effect of a weakening in the domestic
and  international  economies which potentially  impacts capital  investments by
customers,  (2)  the  cyclical  nature  of  funding  within  federal  and  state
government   agencies,   (3)  competition   from  similar   products,   (4)  the
implementation of other  technologies which may provide  alternative  solutions,
and (5) the stability of sole source suppliers.


NOTE B - ACCOUNTING POLICIES

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

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

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

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

Goodwill:  Goodwill  consists  of the  excess  of cost  over the  fair  value of
identifiable  net  assets  of  businesses  acquired  and  were  amortized  on  a
straight-line  basis  over five to twenty  years.  Beginning  January  1,  2002,
goodwill is no longer  amortized,  but is tested on at least an annual basis for
impairment, see Note C.


                                       36
<PAGE>


Long-Lived Assets: Long-lived assets are recorded at the lower of amortized cost
or fair  value.  As part of an ongoing  review of the  valuation  of  long-lived
assets,  the Company  assesses  the  carrying  value of such assets if facts and
circumstances  suggest they may be impaired.  If this review  indicates that the
carrying  value  of  these  assets  may not be  recoverable,  as  determined  by
nondiscounted  cash flow analysis over the remaining  useful life,  the carrying
value would be reduced to its estimated fair value.  There have been no material
impairments recognized in these financial statements.  Software license acquired
in 1999 was amortized on a straight-line basis over 3 years.

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, 2002 and 2001 and  approximate the carrying value
of these financial instruments.

Revenue   Recognition:   Revenues   relating  to  sales  of  certain   equipment
(principally  optical  character  recognition  equipment)  are  recognized  upon
acceptance,  shipment,  or  installation  depending  on the  contract  terms and
conditions.  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  under systems  integration  and  professional  services  contracts are
recognized on the basis of the ratio of earned revenue to total contract  price,
after  considering  accumulated  costs  and  estimated  costs to  complete  each
contract or when  services have been  performed  and accepted,  depending on the
nature of the project.  Under fixed price contracts,  the Company may encounter,
and on certain contracts, in prior years, has encountered,  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, such loss is provided for when identified.

Revenues from maintenance services are recognized as earned.

Income Taxes:  Deferred  income taxes are provided for  differences  between the
income tax and the financial  reporting  bases of assets and  liabilities at the
statutory tax rates that will be in effect when the  differences are expected to
reverse. A valuation allowance for deferred tax assets is recorded to the extent
the Company cannot  determine that the ultimate  realization of net deferred tax
assets is more likely than not.  In making such  determination,  the Company 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.

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.


                                       37
<PAGE>


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

For the purpose of pro-forma disclosures,  the estimated fair value of the stock
options is expensed ratably over the vesting period,  which is 36 months for key
employees and 6 months for the Board of Directors. Options for senior management
that were granted on December  31, 2001 as part of the total debt  restructuring
are  exercisable  six months after the date of grant.  The  Company's  pro-forma
information follows:

<TABLE>
<CAPTION>

                                                                      December 31
(thousands, except per share amounts)                       2002           2001          2000
--------------------------------------------------------------------------------------------------

<S>                                                     <C>           <C>            <C>
Net income (loss), as reported                          $       831   $   (6,313)    $  (17,770)
Stock option expense                                           (199)        (134)           (51)
                                                        ------------------------------------------
Pro forma net income (loss)                             $       632   $   (6,447)    $  (17,821)
                                                        ==========================================
Basic earnings (loss) per share, as reported            $       .12      $  (.90)    $    (2.53)
Stock option expense                                           (.03)        (.02)          (.01)
Pro forma basic earnings (loss) per share               $       .09      $  (.92)    $    (2.54)
                                                        ==========================================
Diluted earnings (loss) per share, as reported          $       .11      $  (.90)   $     (2.53)
Stock option expense                                           (.03)        (.02)          (.01)
Pro forma diluted earnings (loss) per share             $       .08      $  (.92)   $     (2.54)
                                                        ==========================================

</TABLE>


The  weighted-average  fair value of  options  granted  was $.34,  $.24 and $.46
during  2002,  2001,  and 2000,  respectively.  The  weighted-average  remaining
contractual life of the options outstanding at December 31, 2002 was 7 years.

Option  valuation  models  require  the input of highly  subjective  assumptions
including  the expected  stock price  volatility.  The  assumptions  used in the
valuation model were: risk free interest rate - 7%, expected life - 10 years and
expected volatility of 1.39.

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

Earnings  (Loss)  Per  Share:  Basic and  diluted  earnings  (loss) per share is
calculated in accordance  with FASB Statement No. 128,  Earnings Per Share.  For
2001 and 2000,  the effect of stock  options was  antidilutive,  therefore,  the
amounts reported for basic and diluted earnings (loss) per share were the same.


                                       38
<PAGE>


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

Reclassifications:  Certain  2001 and 2000  amounts  have been  reclassified  to
conform to the current year presentation.

New Accounting Pronouncements:

The Company adopted the Financial  Accounting Standards Board ("FASB") Statement
of  Financial  Accounting  Standards  ("SFAS")  No.  142,  "Goodwill  and  Other
Intangible Assets". effective January 1, 2002. This standard addresses financial
accounting and reporting for acquired  goodwill and other intangible  assets and
supercedes  APB  Opinion  No. 17,  "Intangible  Assets".  Under  this  standard,
goodwill and other  intangible  assets  deemed to have  indefinite  lives are no
longer amortized but are subject to annual  impairment tests on a reporting unit
level.  Other intangible  assets are being amortized over their estimated useful
lives.

In August 2001, the FASB issued SFAS No. 144,  "Accounting for the Impairment or
Disposal of Long-Lived Assets". This standard addresses financial accounting and
reporting for the  impairment or disposal of  long-lived  assets and  supercedes
SFAS No.  121,  "Accounting  for the  Impairment  of  Long-Lived  Assets and for
Long-Lived  Assets to Be Disposed  of".  The Company  adopted  this  standard on
January  1, 2002 and such  adoption  did not have an impact on its  consolidated
financial position or results of operations.

In April 2002, the FASB issued SFAS No. 145,  "Rescission of FASB Statements No.
4, 44, and 64,  Amendment of FASB Statement No. 13, and Technical  Corrections".
This  standard   rescinds  SFAS  No.  4,   "Reporting   Gains  and  Losses  from
Extinguishment  of Debt",  and an  amendment  of that  Statement,  SFAS No.  64,
"Extinguishments  of  Debt  Made to  Satisfy  Sinking-Fund  Requirements".  This
standard  amends  SFAS  No.  13,  "Accounting  for  Leases",   to  eliminate  an
inconsistency related to the required accounting for sale-leaseback transactions
and certain  lease  modifications.  This  standard  also amends  other  existing
authoritative  pronouncements  to make various  technical  corrections,  clarify
meanings, or describe their applicability under changed conditions.  The Company
will adopt this  standard on January 1, 2003,  and such adoption is not expected
to  have  an  impact  on its  consolidated  financial  position  or  results  of
operations.

In June 2002,  the FASB issued SFAS No. 146,  "Accounting  for Costs  Associated
with Exit or Disposal Activities".  This standard addresses financial accounting
and reporting for costs associated with exit or disposal activities and requires
companies to recognize costs  associated  with exit or disposal  activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. This standard  nullifies EITF Issue No. 94-3,  "Liability  Recognition for
Certain  Employee  Termination  Benefits  and  Other  Costs to Exit an  Activity
(including  Certain  Costs  Incurred  in a  Restructuring)".  Adoption  of  this
standard beginning in the first quarter of 2003 is expected to impact the timing
of the  recognition  of the  costs  associated  with  future  exit  or  disposal
activities, if any.


                                       39
<PAGE>


In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure  Requirements for Guarantees,  Including  Indirect  Guarantees of
Indebtedness of Others".  This interpretation  requires certain guarantees to be
initially   recognized  and  recorded  at  fair  value  and  also  requires  new
disclosures  related to guarantees even if the likelihood of a guarantor  having
to make  payments  under the  guarantees  is remote.  The Company  adopted  this
interpretation  as of December 31, 2002 and such adoption did not have an impact
on the Company's  consolidated  financial position,  results of operations or on
disclosures in the financial statements.

In December  2002,  the FASB issued SFAS No. 148,  "Accounting  for  Stock-Based
Compensation--Transition  and Disclosure".  This standard  provides  alternative
methods of  transition of the fair value method of  accounting  for  stock-based
employee   compensation   under  SFAS  No.  123,   "Accounting  for  Stock-Based
Compensation,"  but does not require  the Company to use the fair value  method.
This standard also amends certain disclosure requirements related to stock-based
employee compensation. The Company adopted the additional disclosure required of
this standard as of December 31, 2002.


NOTE C- Acquisition Activities

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

On June 19,  2001 the Company  reached a  settlement  with the former  owners of
Southern  Computer  Systems (SCS)  regarding  certain  disputes that arose under
their original stock purchase  agreement executed in June 1998 pursuant to which
Scan-Optics  acquired  100% of the equity in SCS. As part of the stock  purchase
agreement,  Scan-Optics  was  required  to make  certain  payments to the former
owners of SCS in connection  with a consulting and  non-compete  agreement.  The
stock purchase  agreement also required the deposit of funds in a representation
and  warranty  general  escrow,  which  funds were to be  released to the former
owners of SCS on the second  anniversary  following  the date of  purchase.  The
settlement  provided for the release of all claims made by Scan-Optics  relating
to the former  owners'  representations  and  warranties  and the release of all
claims made by the former  owners  against  Scan-Optics.  In  exchange  for this
release,  the former  owners  forgave $.5 million due under the  consulting  and
non-compete  agreements  and made a cash payment from the general escrow account
of $.4  million to  Scan-Optics.  The  forgiveness  of the $.5  million  for the
consulting and non-compete  retainer was recorded as a reduction in Scan-Optics'
general  and  administrative  expense  in the second  quarter  of 2001.  The $.4
million  payment  from  the  general  escrow  account  was  accounted  for as an
adjustment of the original purchase price through a decrease in goodwill.


                                       40
<PAGE>


NOTE D - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS

Unbilled  amounts in accounts  receivable  under  contracts in progress were $.4
million  and $.9 million at December  31, 2002 and 2001,  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
2003.


NOTE E- INVENTORIES

The components of inventories were as follows:
                                                            December 31
(thousands)                                              2002             2001
-------------------------------------------------------------------------------
Finished goods                                     $       56       $      199
Work-in-process                                         1,325            1,604
Service parts                                           3,715            3,941
Materials and component parts                           4,043            2,799
                                                     -------------------------
                                                     $  9,139          $ 8,543
                                                     =========================


NOTE F - CREDIT ARRANGEMENTS

Notes payable reflect  borrowings  under a credit agreement  ("Agreement")  with
Patriarch  Partners,  LLC.  ("Patriarch").  The Agreement  allows for borrowings
under a revolving  line of credit  facility of $10 million and a term loan of $2
million.

Effective  December 31, 2001, the Company  restructured its loan agreements with
Patriarch, which included the following terms:

o    The maturity date of the  Agreement  with  Patriarch  was extended  through
     December 31, 2004.

o    Patriarch's  commitment  under the  Company's  existing  revolving  line of
     credit was  increased  from $10  million to $10.75  million  until June 30,
     2002, at which point the  commitment  amount  returned to $10 million.  All
     revolving loans continue to accrue interest at a rate of prime plus 2%.

o    The  Company's  existing  term loan was  reduced  from $8.5  million  to $2
     million  ($2  million  outstanding  at  December  31,  2002 and  2001)  and
     continues  to accrue  interest  at a rate of prime  plus 2%.  No  principal
     payments are required on the term loan until maturity on December 31, 2004.
     The agreement contains a provision that allows for the quarterly  recapture
     of fifty  percent of the  excess  cash flow to be applied to the term loan,
     based upon the  calculation of  consolidated  cash flow minus the aggregate
     amount of consolidated financial obligations.


                                       41
<PAGE>


o    The Company issued to Patriarch,  shares of preferred stock and warrants to
     purchase  common stock in exchange for  forgiveness  of the remaining  $6.5
     million balance of the term loan.

o    The  warrants  represent  the right to purchase up to  4,975,000  shares of
     common  stock  of the  Company,  or  approximately  33%  of  the  currently
     outstanding shares, plus shares reserved for stock options. The Company may
     repurchase the warrants once the term loan and revolving loan are paid off,
     if the Company also redeems the preferred  stock.  The repurchase  price of
     the warrants is $2.7 million plus accrued interest calculated at prime plus
     2%. In addition,  if the warrants are repurchased in 2003, the Company must
     issue to Patriarch  additional  shares  representing  15% of the  Company's
     common stock.  This amount  increases to 30% in 2004.  The warrants are not
     exercisable  until after  December 31, 2004,  except upon certain events of
     default. The exercise price of the warrants is $.02 per share. The warrants
     are accounted for as an equity instrument through an increase to additional
     paid in capital.

o    The mandatory  redeemable preferred stock ("preferred stock") is subject to
     redemption  for $3.8 million plus interest at prime plus 2% on December 31,
     2004.  The  preferred  stock is  non-voting  except  upon  exercise  of the
     warrants.  The  preferred  stock is accounted as a quasi equity  instrument
     found on the balance  sheet  between other  liabilities  and  stockholders'
     equity.

o    All monthly lease  payments owed to Patriarch have been deferred and become
     due on December 31, 2004.  The lease  obligation  that accrues on a monthly
     basis will be added to the term loan.

o    The Agreement  contains  covenants which,  among other things,  require the
     maintenance of minimum  earnings before interest,  taxes,  depreciation and
     amortization,  capital  expenditure  spending limits,  accounts  receivable
     write-offs and backlog levels.

As a result of the debt  restructuring the term loan as of December 31, 2001 was
reduced by $6.5  million and  warrants to purchase  common stock of $2.7 million
were  recorded  as paid in  capital  and  preferred  stock of $3.8  million  was
recorded, accordingly, no gain resulted from the transaction.

As of December  31,  2002,  the Company  executed an  amendment to the loan with
Patriarch to modify the capital expenditure covenant,  from a maximum of $50,000
per quarter, to a maximum of $375,000 per year.

At December 31, 2002, the Company had $10.5 million in  outstanding  borrowings.
The  revolving  line of  credit  has  been  classified  as long  term,  with the
exception  of $1.5  million  classified  as current,  since  management  has the
ability to maintain the December 31, 2002  outstanding  balance  through  fiscal
year 2003. The available balance on the outstanding  borrowings was $1.5 million
and $.9 million at December 31, 2002 and December  31, 2001,  respectively.  The
weighted average  interest rate on borrowings  during 2002 and 2001 was 5.5% and
9.8%, respectively.

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


                                       42
<PAGE>


NOTE G- CAPITAL STOCK

The Board of Directors is authorized to issue shares of the Company's  preferred
stock in  series,  to  establish  from  time to time the  number of shares to be
included  in each series and to fix the  designation,  powers,  preferences  and
other terms and conditions  with respect to such stock.  As of December 31, 2002
and  2001,   3,800,000  shares  of  mandatory  redeemable  preferred  stock  are
outstanding. These shares do not contain voting rights until the warrants issued
to Patriarch are exercised.

At December 31, 2002, the Company had reserved  2,852,955 shares of common stock
for the  issuance or exercise of stock  options.  The Company has also  reserved
4,975,000 shares of common stock, as part of the total debt  restructuring,  for
the exercise of warrants. (See Note F.)

Class A Convertible  stock has the same rights as common stock,  except that its
holders may not vote for the election of directors,  and it is convertible  into
common stock on a share for share basis.  On September 2, 1994, all  outstanding
shares of Class A Convertible  stock were  converted to common stock.  No shares
were outstanding at December 31, 2002 and 2001.


NOTE H - STOCK OPTION PLANS

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

The Company has 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.  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.


                                       43
<PAGE>


The following  schedule  summarizes the changes in stock options for each of the
three years in the period ended December 31, 2002:
<TABLE>
<CAPTION>


                                                              Number of           Option Price
                                                               Shares               Per Share
------------------------------------------------------------------------------------------------
<S>                                                           <C>             <C>         <C>
Outstanding January 1, 2000 (560,457 exercisable)             754,983         $1.50  to   $9.19
  Granted                                                     561,700           .31  to    1.06
  Surrendered                                                 (42,500)         6.38  to    9.19
  Exercised                                                   (43,500)         2.00  to    2.00
  Canceled                                                   (108,550)         1.06  to    5.75
                                                            -----------------------------------
Outstanding December 31, 2000 (545,245 exercisable)         1,122,133           .31  to    9.19

2001 Activity
  Granted                                                   1,145,000           .24  to     .25
  Canceled                                                    (69,050)          .31  to    3.69
                                                            -----------------------------------
Outstanding December 31, 2001 (782,261 exercisable)         2,198,083           .24  to    9.19

2002 Activity
  Granted                                                      30,000           .34  to     .34
  Canceled                                                   (236,800)          .24  to    9.19
                                                            -----------------------------------
Outstanding December 31, 2002 (1,869,142 exercisable)       1,991,283          $.24  to   $9.19
                                                            ===================================

</TABLE>

At December 31, 2002 there were  861,672  options  available  for grant of which
85,000 were reserved for the Directors.


NOTE I - RESEARCH AND DEVELOPMENT AGREEMENTS

During  2002,  2001 and 2000,  the Company  completed  a number of small  custom
development   contracts   for  specific   customers   resulting  in  revenue  of
approximately  $43,000,  $110,000 and  $200,000,  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  and in 2001,  the employer  match was  increased to 67% of the
first 6%. The Company's  contributions to this plan were $346,000,  $254,000 and
$306,000, in 2002, 2001 and 2000, respectively.


                                       44
<PAGE>


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. The Company
did not allocate any  additional  shares to the Plan in 2002,  2001 or 2000.  At
December  31,  1998,  all  shares  had  been  allocated.  The  Company,  at  its
discretion, may make annual allocations to the Plan in the future. There were no
expenses related to the Plan in 2002, 2001 and 2000.


NOTE K - INCOME TAXES

At  December  31, 2002 the Company  has U.S.  federal and state  operating  loss
carryforwards of approximately $ 27,200,000 and  $26,000,000,  respectively.  At
December  31,  2001,  the Company  has U.S.  federal  and state  operating  loss
carryforwards of approximately  $25,140,000 and $27,630,000,  respectively.  The
U.S. federal and state net operating loss carryforwards  expire through 2015. At
December  31,  2002,  the Company has  approximately  $226,000,  $3,400,000  and
$800,000 of net operating loss  carryforwards for Canada, the United Kingdom and
Germany,  respectively.  At December  31,  2001,  the Company has  approximately
$400,000,  $3,500,000  and  $800,000 of net  operating  loss  carryforwards  for
Canada, the United Kingdom and Germany,  respectively,  which begin to expire in
2003 through 2009. For financial reporting  purposes,  a valuation allowance has
been recorded for 2002 and 2001 to fully offset  deferred tax assets relating to
U.S.  federal,  state,  and foreign net operating loss  carryforwards  and other
temporary differences.

Income (loss) before income taxes is set forth in the following tabulation:
<TABLE>
<CAPTION>


                                                       Year Ended December 31
(thousands)                                       2002             2001            2000
-----------------------------------------------------------------------------------------
<S>                                        <C>                <C>          <C>
Domestic                                   $      700         $(6,270)     $  (17,436)
Foreign                                           212             (10)           (273)
                                           ----------------------------------------------
Income (loss) before income taxes          $      912         $(6,280)     $  (17,709)
                                           ==============================================


Income taxes are summarized as follows:
                                                     Year Ended December 31
(thousands)                                     2002             2001             2000
-----------------------------------------------------------------------------------------
Current :
  State                                    $       80        $      28     $         49
  Foreign                                           1                5               12
                                          ------------------------------------------------
Total current                              $       81        $      33     $         61

  Deferred
-----------------------------------------------------------------------------------------
Total                                      $       81        $      33     $         61
=========================================================================================

</TABLE>


                                       45
<PAGE>


Significant components of the Company's deferred tax liabilities and assets were
as follows:
<TABLE>
<CAPTION>

                                                                 December 31
(thousands)                                                  2002           2001
-------------------------------------------------------------------------------------
 Deferred tax assets:
<S>                                                        <C>                <C>
   Net operating loss carryforward                         $12,005           $ 8,557
   Alternative minimum tax credit carryforward                 168               168
   Depreciation                                                 92                92
   Charitable contribution carryforward                                           37
   Inventory                                                   673               914
   Accounts receivable allowance                               538               669
   Goodwill                                                    119               604
   Vacation accrual                                            172               209
   Other                                                       155               157
      Total gross deferred tax assets                       13,922            11,407

Deferred tax liabilities:
Depreciation and other                                        (306)             (359)
                                                           ---------------------------
      Total gross deferred tax liabilities                    (306)             (359)

Valuation allowance                                        (13,616)          (11,048)
                                                           ---------------------------
      Net deferred tax asset                              $       -     $        -
                                                           ===========================

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

                                                                Year Ended December 31
                                                             2002      2001        2000
----------------------------------------------------------------------------------------
Statutory federal income tax rate                             34%      (34)%       (34)%
  State income taxes, net of federal benefit                   9       .44          .3

  Foreign income taxes                                                              .1

  Valuation allowance                                        (34)       34           34
  Other                                                                .09
                                                             --------------------------
Effective tax rate                                            9%       .53%         .4%
                                                             ==========================

</TABLE>


                                       46
<PAGE>


NOTE L - LEASE COMMITMENTS

The  Company's  principal  lease  commitment  is for its  corporate  office  and
manufacturing facility in Manchester,  Connecticut. The Manchester lease expires
on December  31,  2006.  The  capital  lease  relates to a new phone  system and
photocopiers.  Minimum rental payments for all noncancelable  leases, with terms
equal to or in excess of one year as of December 31, 2002, are as follows:

<TABLE>
<CAPTION>

(thousands)                                                 Operating Leases             Capital Lease
-------------------------------------------------------------------------------------------------------

<S>        <C>                                                <C>                           <C>
           2003                                               $    646                      $     74
           2004                                                    441                            74
           2005                                                    443                            74
           2006                                                    443                            74
           2007                                                     52                            65
           Thereafter                                              312
                                                              --------------------------------------
           Total minimum lease payments                       $  2,337                           361
                                                              ========
           Amounts representing interest                                                         (81)
                                                                                            --------
           Present value of net minimum lease payments                                      $    280
                                                                                            ========

Rental  expense  for the years  ended  December  31,  2002,  2001,  and 2000 was
$681,000, $718,000 and $1,114,000, respectively.

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

</TABLE>

NOTE M - CONTINGENCIES

There are two  lawsuits  currently  pending  against the  Company.  Although the
ultimate  outcome is  uncertain,  based on currently  known  facts,  the Company
believes that it has strong defenses against both lawsuits and the resolution of
these matters will not have a material adverse effect on the Company's financial
position or annual operating results.


                                       47
<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>


                                                                               Year Ended December 31
(thousands)                                                   2002                     2001                  2000
----------------------------------------------------------------------------------------------------------------------

Revenues
<S>                                                         <C>                      <C>                      <C>
  Solutions and products                               $    16,376           $        16,667            $      23,295
  Access services                                           11,499                    13,193                   12,669
  Contract manufacturing services                            1,466                       880                    2,338
                                                      ----------------------------------------------------------------
    Total revenues                                          29,341                    30,740                   38,302

Cost of solutions and products                              10,715                    13,298                   22,806
Service expenses                                             8,539                    11,200                   11,287
                                                      ----------------------------------------------------------------

    Gross profit margin                                     10,087                     6,242                    4,209

  Operating expenses, net                                    9,175                    12,522                   21,918
                                                      -----------------------------------------------------------------
Income (loss) before income taxes                      $       912           $        (6,280)           $     (17,709)
                                                      =================================================================

Total assets                                           $    26,406           $        27,380            $      36,513

Total  expenditures  for  additions to long-lived
assets                                                 $        79           $           121            $         109

</TABLE>


Certain 2001 and 2000 amounts have been  reclassified  to conform to the current
year presentation.

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.

Note:  In 2002 and  2001,  no  customers  accounted  for more  than 10% of total
revenue.  In  2000,  the  Company  derived  13% of its  total  revenue  from one
customer, Toyo Officemation, Inc., one of the Company's distributors in Japan.


                                       48
<PAGE>


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.

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

<TABLE>
<CAPTION>


(thousands)                          2002                  2001                 2000
--------------------------------------------------------------------------------------------

<S>                       <C>          <C>                 <C>                   <C>
Latin America             $            72   24%        $    152    3%       $    152     2%
Europe                                149   49%           3,706   73%          1,667    22%
Pacific Rim                            81   27%           1,220   24%          5,881    76%
                          ------------------------------------------------------------------
                          $           302              $  5,078             $  7,700
                          ==================================================================
</TABLE>

Export sales  represented 3%, 45%, and 43% of hardware and software revenues for
the three years ended December 31, 2002, 2001, and 2000, respectively.


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 2002, 2001, and 2000 included bill and hold transactions of $1.3 million,
$.1 million and $1.7 million,  respectively.  Accounts  receivable included bill
and hold  receivables  of $1.1 million,  $.1 million and $.4 million at December
31, 2002, 2001 and 2000, respectively.

                                       49

<PAGE>


NOTE P - EARNINGS PER SHARE

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

<TABLE>
<CAPTION>


                                                                 December 31
(thousands, except share data)                         2002           2001             2000
--------------------------------------------------------------------------------------------------

Numerator:
<S>                                                       <C>          <C>           <C>
      Net earnings (loss)                                 $ 831        $ (6,313)     $ (17,770)
                                                  ================================================

Denominator:
      Denominator for basic earnings (loss)
      per share (weighted-average shares)              7,026,232       7,026,232      7,025,064

      Effect of dilutive securities:
      Employee stock options                             291,205

      Denominator for diluted earnings (loss)
      per share (adjusted weighted-average
                                                  ------------------------------------------------
      shares and assumed conversions)                  7,317,437       7,026,232      7,025,064

Basic earnings (loss) per share                          $   .12        $  (.90)       $  (2.53)
                                                  ================================================

Diluted earnings (loss) per share                        $   .11        $  (.90)       $  (2.53)
                                                  ================================================

</TABLE>


For 2001 and 2000, the effect of stock options was antidilutive,  therefore, the
amounts reported for basic and diluted earnings (loss) per share were the same.


                                       50
<PAGE>


NOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly  results of operations for the years
ended December 31, 2002 and 2001.



<TABLE>
<CAPTION>


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

2002
<S>                                          <C>                   <C>               <C>
Revenues                                     $    7,824 $  7,842   $    7,242        $   6,433
Cost of product sales and service expenses        5,065    5,143        4,718            4,328
Net income                                          166      218          220              227
Basic earnings per share                            .02      .03          .03              .03
Diluted earnings per share                   $      .02  $   .03   $      .03        $     .03

2001
Revenues                                     $    10,908 $ 6,991   $    5,586        $   7,255
Cost of product sales and service expenses         8,336   5,338        4,547            6,277
Net loss                                           (664)    (940)      (1,809)          (2,900)
Basic loss per share                               (.09)    (.13)        (.26)            (.41)
Diluted loss per share                       $     (.09) $  (.13)  $     (.26)       $    (.41)

</TABLE>


Fourth  quarter  2002 net income of $.2  million  includes  other  income of $.4
million  or $.05  per  share  resulting  from a  reduction  of  certain  amounts
previously  recorded as liabilities that were no longer due or have been settled
for amounts less than previously recorded.

Third quarter 2002 net income of $.2 million includes a negotiated  reduction of
$.3 million or $.04 per share.  This reduction in the final payment due Bluebird
Systems for the 1999 purchase of the Docwise source code license resulted in the
reduction of previously recorded research and development amortization expense.

Fourth quarter 2001 net loss of $2.9 million includes charges to expense of $1.5
million or $.21 per share.  The major  components of these  charges  include $.4
million  of  inventory  reserves  related  to  obsolete  parts,  $.2  million of
additional  amortization  of Access  Services  parts  inventory,  $.2 million of
accrued severance costs, $.3 million of accrued lease expense and $.4 million of
a management stay bonus.


                                       51
<PAGE>


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

None.






                                    PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------

Information  pertaining to Directors and  additional  information  pertaining to
Executive  Officers is included  under the captions  "Governance of the Company"
and  "Compliance  with Section 16(a) of the Securities  Exchange Act of 1934" in
the Company's  definitive proxy statement for the Annual Meeting of Stockholders
to be held on June 12, 2003 and is  incorporated  herein by reference and made a
part hereof.

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

This information is included in the Company's definitive proxy statement for the
Annual Meeting of  Stockholders  to be held on June 12, 2003 and is incorporated
herein by reference.


                                       52
<PAGE>


ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------
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 for
the Company's 2003 Annual Meeting of  Shareholders  filed pursuant to Regulation
14A,  which is  incorporated  by  reference  herein.  The Company has six equity
compensation  plans  as of  December  31,  2002.  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,
2002.



<TABLE>
<CAPTION>




                                                                                                  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)
------------------------------------------------------------------------------------------------------------------------------

<S>                                                        <C>                  <C>                         <C>
Equity compensation plans approved by
stockholders                                               966,283              $  2,472,445                861,672
Equity compensation plans not
approved by stockholders:
     Senior management options                           1,025,000                   246,000
     Debt restructuring warrants                         4,975,000                 2,700,000

                                              --------------------------------------------------------------------------------
                                                         6,966,283              $  5,418,445                861,672
                                              ================================================================================

</TABLE>

Equity  compensation  plans not  approved by  stockholders  include  options for
senior management and warrants issued to Patriarch,  which were both part of the
total debt  restructuring.  Options for senior  management  that were granted on
December 31, 2001 were not exercisable until six months after the grant thereof.
See Note H to the Notes to  Consolidated  Financial  Statements  of the  Company
included in this report for additional  information.  The warrants represent the
right to purchase up to  4,975,000  shares of common  stock of the  Company,  or
approximately 33% of the currently  outstanding  shares. See Note F to the Notes
to Consolidated  Financial Statements of the Company included in this report for
additional information.


                                       53
<PAGE>


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

This  information is included under the caption  "Certain  Transactions"  in the
Company's  definitive  proxy statement for the Annual Meeting of Stockholders to
be held on June 12, 2003 and is incorporated herein by reference.



ITEM 14 - 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  within the 90-day  period prior to the filing of 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-14(c)  and
15d-14(c),  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  to  the   Company's   internal   controls  or  other  factors  that  could
significantly affect these controls subsequent to the date of their evaluation.



                                       54
<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 Independent Auditors

                      Consolidated Balance Sheets at December 31, 2002 and 2001

                      Consolidated Statements of Operations for the years ended
                      December 31, 2002, 2001 and 2000

                      Consolidated Statements of Stockholders' Equity for the
                      years ended December 31, 2002, 2001 and 2000

                      Consolidated Statements of Cash Flows for the years ended
                      December 31, 2002, 2001 and 2000

                      Notes to Consolidated Financial Statements -
                      December 31, 2002

         (2)          The following consolidated financial statement schedule is
                      included in Item 15(a):

                Schedule II -- Valuation and Qualifying Accounts


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

         (3)               Listing of Exhibits
                           -------------------

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

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

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


                                       55
<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 10.10 in the Company's
                              Annual  Report  on Form  10-K  filed  for the year
                              ended December 31, 1996.

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

                    *+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.


                                       56
<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   Executive  severance  agreement between Michael J.
                              Villano and  Scan-Optics,  Inc. dated November 17,
                              1997,  is filed as Exhibit  10.15 in the Company's
                              Annual  Report  on Form  10-K  filed  for the year
                              ended December 31, 1999.

                    *+10.16   Executive severance agreement between Alan W. Ware
                              and Scan-Optics, Inc. dated May 22, 2001, is filed
                              as Exhibit 10.16 in the Company's Quarterly Report
                              on Form 10-Q filed for the quarter  ended June 30,
                              2001.

                    *10.17    Certificate of Designations,  Preferences,  Rights
                              and Restrictions for Series A Redeemable Preferred
                              Stock dated December 31, 2001, is filed as Exhibit
                              3.3 in the  Company's  Registration  Statement  on
                              Form S-8 (No. 333-83598), filed on March 1, 2002.

                    *10.18    Warrant  to  Purchase  Shares of  Common  Stock of
                              Scan-Optics,  Inc.  dated  December 31,  2001,  is
                              filed as  Exhibit  10.18 in the  Company's  Annual
                              Report  on Form  10-K  filed  for the  year  ended
                              December 31, 2001.

                    *10.19    Fourth  Amendment  Agreement  dated as of December
                              31,  2001  between  ARK CLO  2000-1,  Limited  and
                              Scan-Optics,  Inc. and prior loan  agreements,  is
                              filed as  Exhibit  10.19 in the  Company's  Annual
                              Report  on Form  10-K  filed  for the  year  ended
                              December 31, 2001.

                    10.20     Fifth Amendment Agreement dated as of December 31,
                              2002   between   ARK  CLO   2000-1,   Limited  and
                              Scan-Optics,  Inc. and prior loan  agreements,  is
                              filed as  Exhibit  10.20 in the  Company's  Annual
                              Report  on Form  10-K  filed  for the  year  ended
                              December 31, 2002.

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

                    23.       Consent of Independent Auditors.

                    99.1      Certification of Chief Executive  Officer pursuant
                              to Section 906 of the Sabanes-Oxley Act.

                    99.2      Certification of Chief Financial  Officer pursuant
                              to Section 906 of the Sabanes-Oxley Act.

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


                                       57
<PAGE>


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

                 (b) Reports on Form 8-K
                 -----------------------

                      No  report on Form 8-K was  filed  for the  quarter  ended
                      December 31, 2002.

                 (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.



                                       58
<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:              /ss/
                                        -------------------------------------
                                        James C. Mavel
                                        Chairman, Chief Executive Officer and
                                        President
                                        Date: March 26, 2003

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.

                /ss/
----------------------
James C. Mavel                  Chairman, Chief Executive Officer and President
                               (Principal Executive Officer)
                                Date:        March 26, 2003
                /ss/
----------------------
Michael J. Villano              Chief Financial Officer, Vice President and
                                Treasurer
                               (Principal Financial and Accounting Officer)
                                Date:        March 26, 2003

                /ss/
----------------------
Logan Clarke, Jr.               Director      March 26, 2003

                /ss/
----------------------
Richard J. Coburn               Director      March 26, 2003

                /ss/
----------------------
E. Bulkeley Griswold            Director      March 26, 2003

                /ss/
----------------------
Lyman C. Hamilton, J            Director      March 26, 2003

                /ss/
----------------------
John J. Holton                  Director      March 26, 2003

                /ss/
----------------------
Robert H. Steele                Director      March 26, 2003

A majority of the Directors


                                       59
<PAGE>


                    CERTIFICATION OF CHIEF EXECUTIVE OFFICER


         I, James C. Mavel, Chairman, Chief Executive Officer and President of
Scan-Optics, Inc., certify that:

         1. I have reviewed this annual report on Form 10-K of Scan-Optics,
Inc.;

         2. Based on my  knowledge,  this  annual  report  does not  contain any
untrue  statement of a material fact or omit to state a material fact  necessary
to make the  statements  made,  in light of the  circumstances  under which such
statement were made,  not misleading  with respect to the period covered by this
annual report;

         3. Based on my knowledge, the financial statements, and other financial
information  included  in this annual  report,  fairly  present in all  material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

         4. The registrant's other certifying officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

                  a) Designed such disclosure  controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this annual report is being prepared;

                  b) Evaluated the effectiveness of the registrant's  disclosure
controls and  procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

                  c) Presented in this annual report our  conclusions  about the
effectiveness of the disclosure  controls and procedures based on our evaluation
as of the Evaluation Date;

         5. The  registrant's  other  certifying  officers and I have disclosed,
based on our most recent evaluation,  to the registrant's auditors and the audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent function):

                  a) All significant  deficiencies in the design or operation of
internal  controls  which could  adversely  affect the  registrant's  ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

                  b)  Any  fraud,   whether  or  not  material,   that  involves
management or other  employees who have a significant  role in the  registrant's
internal controls; and


                                       60
<PAGE>


         6. The registrant's  other certifying  officers and I have indicated in
this annual  report  whether or not there were  significant  changes in internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant deficiencies and material weaknesses.


Date: March 26, 2003


                       ________/ ss_/____________________
                                            James C. Mavel
                        Chairman, Chief Executive Officer
                                            and President



                                       61
<PAGE>



                    CERTIFICATION OF CHIEF FINANCIAL OFFICER


         I, Michael J. Villano, Chief Financial Officer, Vice President and
Treasurer of Scan-Optics, Inc., certify that:

         1. I have  reviewed  this  annual  report on Form 10-K of  Scan-Optics,
Inc.;

         2. Based on my  knowledge,  this  annual  report  does not  contain any
untrue  statement of a material fact or omit to state a material fact  necessary
to make the  statements  made,  in light of the  circumstances  under which such
statement were made,  not misleading  with respect to the period covered by this
annual report;

         3. Based on my knowledge, the financial statements, and other financial
information  included  in this annual  report,  fairly  present in all  material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

         4. The registrant's other certifying officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

                  a) Designed such disclosure  controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this annual report is being prepared;

                  b) Evaluated the effectiveness of the registrant's  disclosure
controls and  procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

                  c) Presented in this annual report our  conclusions  about the
effectiveness of the disclosure  controls and procedures based on our evaluation
as of the Evaluation Date;

         5. The  registrant's  other  certifying  officers and I have disclosed,
based on our most recent evaluation,  to the registrant's auditors and the audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent function):

                  a) All significant  deficiencies in the design or operation of
internal  controls  which could  adversely  affect the  registrant's  ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

                  b)  Any  fraud,   whether  or  not  material,   that  involves
management or other  employees who have a significant  role in the  registrant's
internal controls; and

         6. The registrant's  other certifying  officers and I have indicated in
this annual  report  whether or not there were  significant  changes in internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant deficiencies and material weaknesses.


Date: March 26, 2003

                                     _______/ ss /_____________________
                                     Michael J. Villano
                                     Chief Financial Officer, Vice President
                                     and Treasurer


                                       62
<PAGE>




                                                     SCHEDULE II

<TABLE>
<CAPTION>


                                                     SCAN-OPTICS, INC. AND SUBSIDIARIES
                                                     VALUATION AND QUALIFYING ACCOUNTS
                                             THREE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
                                                                 (thousands)

                  COLUMN A                       COLUMN B                 COLUMN C                COLUMN D               COLUMN E
                                                                         Additions
                                                              ---------------------------------
                                                Balance at      Charged to       Charged to                             Balance at
                                                Beginning        Costs and         Other                                  End of
              Description                       Of Period        Expenses         Accounts       Deductions               Period
------------------------------------------------------------------------------------------------------------------------------------

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

Year ended December 31, 2001:                  $       5,615  $            93                   $    3,772(1)       $     1,936
      Allowance for doubtful accounts
          (billed and unbilled)

Year ended December 31, 2000:                  $         308   $        5,505  $   13  (2)      $     211 (1)       $     5,615
      Allowance for doubtful accounts
         (billed and unbilled)
</TABLE>



(1) Uncollectible accounts written off, net of recoveries.
(2) Represents reclassifications from other accounts.

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


                                       63