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, 2003

( )  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. [ ]

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

The aggregate  market value of the voting and  non-voting  common equity held by
non-affiliates  computed by reference  to the price at which  common  equity was
last sold, or the average bid and asked price of such common  equity,  as of the
last day of the  registrant's  most recently  completed  second fiscal  quarter:
$2,083,125 as of June 30, 2003.

The number of shares of common stock,  $.02 par value,  outstanding  as of March
24, 2004 was 7,439,732.

                                       1
<PAGE>


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

Portions of the definitive Proxy Statement,  relating to the 2004 Annual Meeting
of  Stockholders,  which  will be  filed  pursuant  to  Regulation  14A with the
Securities and Exchange  Commission not later than 120 days after the end of the
fiscal year, are incorporated by reference and included in the following:

Part III-Item 10 - Directors and Executive Officers of the Registrant
Part III-Item 11 - Executive Compensation
Part III-Item 12 - Security Ownership of Certain Beneficial Owners and
                   Management
Part III-Item 13 - Certain Relationships and Related Transactions
Part III-Item 14 - Principal Accountant Fees and Services




                                       2

<PAGE>

                                     PART I

ITEM 1 - BUSINESS
-----------------

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

The Company 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.


                                       3
<PAGE>


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 20 companies to provide  maintenance  services
for their products at customer sites or through the Company's depot  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 34
years of experience serving specific target markets.

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

The  Company's  target  markets for 2004 include its  customer  base of data and
image capture and processing  customers,  the Federal  Government market and the
Value-Added Reseller/Channel market.


                                       4
<PAGE>


Scan-Optics' corporate message consists of a "Services-Led  Strategy" - which is
a focused services  approach vs. a product  approach,  and which  communicates a
Services-Led  message that  emphasizes  Scan-Optics'  key values in implementing
successful   information  capture  solutions  in  high-volume  paper  processing
environments.

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.

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
AccuScore  is  currently  being used by three of the top Large Scale  Assessment
processors and is well  positioned to facilitate  the increased  demand for test
scoring created by the "No Child Left Behind" Act.

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

Scan-Optics' 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'  VistaCapture is a software solution suite for rapid development of
data capture applications.


                                       5
<PAGE>


Scan-Optics'   KeyEntry  III  is  the  ideal   development   tool  for  creating
applications  that work in  conjunction  with  mainframe  computers and personal
computers.  Typical  applications  range from "heads  down" data entry to highly
sophisticated  multi-user  "front-ends" for large corporate databases.

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.

Hardware Products
Scan-Optics' SO Series Scanner  provides a single platform to address high speed
image  capture and high  throughput  intelligent  document  processing  with the
lowest cost/highest performance ratio of any scanner in its class.

Using the latest advancements in technology,  Scan-Optics has re-engineered this
scanner to create a single  platform  that  provides a solution  for  commercial
businesses and government agencies that need high-speed image data capture,  and
high-throughput intelligent document processing. There are two transport options
with the SO Series Scanner; the SO Series Image-Only and the SO Series OCR.

In 2004, 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


                                       6
<PAGE>


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

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.  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  internally  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:



                                       7
<PAGE>


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.


ACCESS SERVICES DIVISION

The Company has offered  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.  In addition to  supporting  Company
products,  the Access Services Division provides service and maintenance support
on a variety of electro-mechanical  products for more than 20 different domestic
and foreign manufactures.

Maintenance  service is  provided  through a network of over 120 highly  skilled
service technicians  including  employees and contractors.  The Company provides
on-site  service with response  times of 2 to 24 hours based on the service plan
selected by the customer.  In support of its third-party  maintenance  contracts
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 the Pacific Rim.
The Company maintains high standards of teamwork and customer satisfaction.


BUSINESS PROCESS OUTSOURCING

Manufacturing 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.


                                       8
<PAGE>


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 this division,  provides
electro-mechanical assembly and test services under contracts with customers who
develop and sell a variety of equipment.

Beginning  with the customer's  plans,  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 utilizes 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 2003,  the  Company  derived  23% of its  total  revenue  from one  customer,
Northrop Grumman, IT Inc. In 2002 and 2001, no customers accounted for more than
10% of total revenue.

CHANNELS OF DISTRIBUTION

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


                                       9
<PAGE>




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.


BACKLOG

The backlog for the Company's  products and services as of December 31, 2003 was
approximately   $15.2  million.  As  of  December  31,  2002,  the  backlog  was
approximately $18.7 million.  Backlog as of March 19, 2004 was approximately $17
million.  The  backlog  consists  of firm  orders for  equipment,  software  and
services,  the majority of which are expected to be delivered within the next 12
months, and maintenance due on existing contracts expected to be provided during
the next 12 months. The Company normally delivers a system within 30 to 180 days
after receiving an order, depending upon the degree of professional services and
software customization required.


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 Solutions and Products 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 34 years of
experience in providing scanner repair.

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

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



PATENTS

The Company  currently  has nine United  States  patents in  force, which expire
between 2004 and 2022,  and one patent  pending.  The patents are on  mechanical
systems, electronic circuits,  electronic systems and software algorithms, which
are used throughout the product lines.  The Company values the investments  made
in new technology and attempts to protect its intellectual property. The Company
expects to continue to apply for patents on its new  technological  developments
when it believes they are significant.  In November 1997, the Company licensed a
patent to Imaging Business Machines,  LLC for use in an image transport designed
for processing  airline tickets.  In 1999, this same patent was licensed to Nale
Corporation for use on its paper handling transports. In 2000, the Company filed
for a patent for gray scale OMR used in test scoring applications.  In 2001, the
Company received the patent for the ultrasonic  overlapping  document  detection
system for our scanners.


                                       11
<PAGE>


EMPLOYEES

As of December  31,  2003 the Company  employed  187 people,  including  19 with
administrative  responsibilities,  16 in marketing and sales, 94 in software and
service activities,  17 in engineering and 41 in manufacturing  capacities.  The
Company  considers  its  employee  relations  to be good.  The  Company  has not
experienced any work stoppages.


FUNDED DEVELOPMENT AGREEMENTS

During  2003,  2002 and 2001,  the Company  completed  a number of small  custom
development   contracts   for  specific   customers   resulting  in  revenue  of
approximately  $200,000,  $43,000 and  $110,000,  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)                                                   2003         2002         2001
---------------------------------------------------------------------------------------------
                                                                       Restated
<S>                                                       <C>          <C>          <C>
Revenues
  Solutions and products                                  $ 21,108     $ 16,376     $ 16,667
  Access services                                           10,563       11,499       13,193
  Contract manufacturing services                              410        1,466          880
                                                          ----------------------------------
    Total revenues                                          32,081       29,341       30,740

Cost of solutions and products                              13,407       10,715       13,298
Service expenses                                             8,813        8,539       11,200
                                                          ----------------------------------

    Gross profit margin                                      9,861       10,087        6,242

  Operating expenses, net                                    9,017        9,064       12,522
                                                          ----------------------------------
Income (loss) before income taxes                         $    844     $  1,023     $ (6,280)
                                                          ==================================

Total assets                                              $ 26,073     $ 26,406     $ 27,380

Total expenditures for additions to long-lived assets
                                                          $    173     $     79     $    121
</TABLE>

The Company  restated the 2002  consolidated  financial  statements to reflect a
change in the application of generally accepted  accounting  principles relating
to certain liabilities.  The net impact of this change increased 2002 net income
before taxes by $111,000,  from the amount previously reported.  Refer to Note B
of the consolidated financial statements for more details.

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

In 2003,  the  Company  derived  23% of its  total  revenue  from one  customer,
Northrop Grumman, IT Inc. In 2002 and 2001, no customers accounted for more than
10% of total revenue.

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.


                                       13
<PAGE>


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

<TABLE>
<CAPTION>
(thousands)         2003                    2002                    2001
---------------------------------------------------------------------------------------

<S>               <C>             <C>     <C>             <C>     <C>              <C>
Latin America     $  124          12%     $   72          24%     $  152           3%
Europe                             0%        149          49%      3,706          73%
Pacific Rim          944          88%         81          27%      1,225          24%
                  ---------------------------------------------------------------------
                  $1,068                  $  302                  $5,083
                  =====================================================================
</TABLE>


Export sales  represented 5%, 2%, and 30% of the Solutions and Products  Segment
revenues  for  the  three  years  ended  December  31,  2003,  2002,  and  2001,
respectively.  There are no exports  sales  derived  from the  Company's  Access
Services Segment or Contract Manufacturing Services Segment.



ITEM 2 - PROPERTIES
-------------------

The Company's world  headquarters  and  manufacturing  facility is located in an
84,000 square foot, one-story building in Manchester,  Connecticut, leased for a
term  expiring in December  2006.  The Company  also leases 1,238 square feet of
office  space,  under a lease  expiring  in July  2005,  in  Dallas,  Texas  for
professional services and sales.

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


ITEM 3 - LEGAL PROCEEDINGS
--------------------------

Since 2001, an action has been pending against Scan-Optics alleging, among other
things,  breach of contract in  connection  with a contract  for the delivery of
hardware,  software  and  professional  services.  Scan-Optics  has  denied  the
material  allegations of the complaint and counterclaimed for breach of contract
and seeks recovery of unpaid  receivables,  totaling $1.4 million.  Although the
ultimate  outcome is  uncertain,  based on currently  known  facts,  the Company
believes  that it has strong  defenses  against the lawsuit and valid claims for
recovery  for the net amount of unpaid  receivables  recorded  in the  financial
statements,  and that the  resolution  of this  matter  will not have a material
adverse effect on the Company's financial position or annual operating results.


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

The Company did not submit any  matters  during the fourth  quarter of 2003 to a
vote of the stockholders.


                                       14
<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 Company's  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 916 stockholders of record at December 31, 2003.


<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>
2003            $  .35         $  .25        $  .65         $  .27         $  .74          $  .50           $  .70         $  .45
2002            $  .41         $  .22        $  .38         $  .26         $  .39          $  .25           $  .40         $  .25
</TABLE>



The  Company  has not  paid  dividends  on its  Common  Stock  and the  Board of
Directors  of the  Company  has  no  intention  of  declaring  dividends  in the
foreseeable  future.  The  Company's  loan  agreement  does not  allow  dividend
payments on common stock.


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



                                       15
<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)                  2003             2002            2001             2000             1999
-----------------------------------------------------------------------------------------------------------------------
                                                             Restated
<S>                                      <C>              <C>             <C>              <C>              <C>
Total Revenues                           $    32,081      $    29,341     $    30,740      $    38,302      $    51,992
                                         ==============================================================================

Income (loss) before income taxes                844            1,023          (6,280)         (17,709)          (8,415)

Income taxes (benefit)                          (142)              81              33               61             (240)
                                         ------------------------------------------------------------------------------

Net Income (Loss)                        $       986      $       942     $    (6,313)     $   (17,770)     $    (8,175)
                                         ==============================================================================

Basic earnings (loss) per share          $       .14      $       .13     $      (.90)     $     (2.53)     $     (1.17)

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

Diluted earnings (loss) per share        $       .13      $       .13     $      (.90)     $     (2.53)     $     (1.17)

Diluted weighted-average shares            7,806,491        7,317,437       7,026,232        7,025,064        6,979,651

SELECTED BALANCE SHEET DATA
Total assets                             $    26,073      $    26,406     $    27,380      $    36,513      $    56,792
Working capital (deficit)                $     4,957      $     5,394     $     4,184      $    (9,833)     $     4,727
Long term obligations                    $     9,865      $    10,682     $    11,397
Mandatory redeemable preferred stock     $     3,800      $     3,800     $     3,800
Total stockholder's equity               $     2,443      $     1,383     $       360      $     4,307      $    22,081
</TABLE>


The Company  restated the 2002  consolidated  financial  statements to reflect a
change in the application of generally accepted  accounting  principles relating
to certain liabilities.  The net impact of this change increased 2002 net income
and  earnings  per  share by  $111,000  and  $.02,  respectively,  from  amounts
previously reported. Refer to Note B of the consolidated financial statments for
more details.

The Company has not paid any dividends for the five-year  period ended  December
31, 2003.

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



                                       16
<PAGE>


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

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

The following list is not intended to be an exhaustive  list of all the risks to
which  the  Company's  business  is  subject,  but  only  to  highlight  certain
substantial  risks faced by the Company.  Although the Company  completed a debt
restructuring  effective March 30, 2004 (see  "Liquidity and Capital  Resources"
for further  information),  the Company  remains  highly  leveraged and could be
adversely  affected by a significant  increase in interest  rates. A one percent
increase  in the prime  rate would  increase  the  annual  interest  cost on the
outstanding loan balance at December 31, 2003 of approximately $8 million by $.1
million. Further, if the recapitalization described under "Liquidity and Capital
Resources"  occurs,  as  contemplated by the 2004 debt  restructuring  described
under such  heading,  the  Company's  lenders  will acquire  significant  voting
control and will accordingly have the right and the ability to influence the way
in which the Company does business,  including its strategy and tactics.  If the
recapitalization  fails to occur, the Company's secured  obligations  (including
the Company's  mandatorily  redeemable  preferred  stock),  which exceeds in the
aggregate  $13.6  million as of March 30, 2004,  will be due and payable June 1,
2005.  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 $1 million or $.13 per diluted
share,  compared to a net income of $.9 million,  or $.13 per diluted share, for
2002.  There was an 18% improvement in operating  income,  along with 9% revenue
growth for the year  compared  to 2002.  In 2003 we received  certification  for
ISO9001:2000  for our  entire  Company,  which  extends  the  focus on  customer
satisfaction  to all areas of the enterprise.  The Company  invested in research
and  development  to develop a new image  scanning  platform  in 2003,  which it
introduced  during the AIIM  trade show in March  2004.  In fact,  this  product
earned "Best in Show Award" for high-end image scanners.  This image scanner was
designed to satisfy the requirement of our very sophisticated  customer base but
also  scalable to provide an  excellent  price  performance  in the  competitive
market space.


                                       17
<PAGE>

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
target  market  approach  and has  chosen  to  place  its  primary  focus on the
government   and   assessment   markets,   while   continuing   to  address  the
transportation,  insurance, 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  $5.1  million  from 2002 to 2003 mainly in the
government 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'  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,  in 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,   including
employees and contractors,  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.


                                       18
<PAGE>


RESULTS OF OPERATIONS - 2003 VS. 2002

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

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

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

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

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

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

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

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

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

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

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


                                       19
<PAGE>

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

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

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


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.


                                       20
<PAGE>


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.

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 $.3 million or 9% 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.
Expenses have been restated from amounts previously  recorded for a reduction in
liabilities  of  $.2  million  offset  by  $.1  million  for  additional   bonus
compensation.

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.


LIQUIDITY AND CAPITAL RESOURCES

The Company  expects to utilize  available  liquid  resources to fund additional
investments in its marketing and research and development organizations, provide
for professional  fees arising from the debt  restructuring  process and general
working capital and corporate needs.

Cash and cash equivalents  increased $.3 million from 2002 to 2003 mainly due to
increased  cash from  operations  offset by the paydown of the revolving line of
credit.

At December  31,  2003,  the Company had $8 million in  outstanding  borrowings,
classified  as long term,  against its $12  million  available  borrowings.  The
Company  anticipates  meeting its current obligations and resource needs through
the funds  generated  from  operations  and  available  borrowings.  The average
borrowing  level for 2003 was $9.8 million  compared to $10.7  million for 2002.
The  decrease is due to payments of portions of the  outstanding  debt from cash
flow generated in 2003.


                                       21
<PAGE>


Effective March 30, 2004, the Company  entered into a new credit  agreement with
lenders  affiliated with Patriarch  Partners,  LLC. (the "Lenders")  that, among
other things,  extends from December 31, 2004 through June 1, 2005 the repayment
date for all of the  Company's  secured  debt and  provides  additional  working
capital in the amount of $1.5 million.  Subject to approval by the  shareholders
at the Company's Annual Meeting  scheduled to be held on or before July 1, 2004,
the Company will issue to the Lenders 79.8% of the fully-diluted Common Stock of
the Company in consideration  for, among other things, the Lenders' agreement to
extend the repayment date for  outstanding  secured debt through March 30, 2007.
More specifically, the financing arrangement includes the following items:


          o The Company's  secured term and revolving debt is exchanged for a $9
     million  term  loan.  The new term loan is  payable  in annual  amounts  of
     $90,000  beginning March 2005 with the balance due at maturity.  A new $2.5
     million  revolving credit facility is also provided,  which can be used for
     working capital and other general  business  purposes.  Borrowings  against
     both such loans will  continue  to accrue  interest at a rate of prime plus
     2%. The maturity date for these loans is extended from December 31, 2004 to
     June 1, 2005.

          o An additional $1.5 million working capital term loan is available to
     the Company,  with the Company obligated to repay $2 million at maturity on
     June 1, 2005.  The working  capital  term loan will  accrue  interest on $2
     million at the prime rate.

          o The Company's financial  covenants with respect to backlog,  capital
     expenditure  and  EBITDA  have  been  modified  to  enhance  the  financial
     flexibility of the Company.

          o The Company has  exchanged the $3.8 million  mandatorily  redeemable
     Series  A  preferred  stock  held  by  the  Lenders  for  $3.8  million  of
     mandatorily  redeemable Series B preferred stock,  which Series B preferred
     stock has  substantially  the same terms as the Series A,  except  that the
     redemption date is extended from December 31, 2004 to June 1, 2005.

          o The  Company  has  agreed to use its best  efforts,  subject  to the
     fiduciary duties of the Board of Directors,  to complete a recapitalization
     of the Company by July 1, 2004. The Lenders  currently hold both the Series
     B preferred stock noted above and a warrant to purchase common stock issued
     to the Lenders in December  2001.  The Lenders are entitled to exercise the
     warrant,  upon the earlier of January 1, 2005 or a  triggering  event,  for
     33.2% of the fully-diluted  common stock of the Company at $0.02 per share.
     In  addition,  upon the  Lender's  exercise  of the  warrant,  the Series B
     preferred  would be entitled  to vote with the common  stock and would have
     46.67% of the voting power of the Company,  on a fully-diluted  basis.  The
     recapitalization  will include,  among other terms, the cancellation of the
     $3.8  million  mandatorily  redeemable  Series B  preferred  stock  and the
     existing  warrant,  and the  issuance of common stock of the Company to the
     Lenders so that  following  such issuance the Lenders will own 79.8% of the
     fully-diluted common stock of the Company,  subject to dilution for certain
     current and future  compensatory  stock options issued by the Company.  The
     recapitalization  is subject to the  approval  by the  stockholders  of the
     Company of an amendment to the certificate of  incorporation of the Company
     to increase the authorized common stock of the Company and related matters,
     which approval will be sought at the Company's planned annual meeting to be
     held on or before July 1, 2004.


                                       22
<PAGE>


          o Upon approval by the Company's  shareholders of the recapitalization
     described  above,  the  maturity  date  for  all of the  Company's  secured
     indebtedness  to the Lenders will be further  extended from June 1, 2005 to
     March 30, 2007.


     The Company believes that the 2004 loan  restructuring will allow execution
of the  Company's  business  plan  through the term of the credit  agreement  by
reducing required payments under the borrowing arrangements with the Lenders and
increasing  available  funds  through the working  capital  term loan  facility,
thereby enhancing the Company's  ability to invest in its business,  by lowering
the thresholds of the financial  covenants and by extending the loan  maturities
through  June 2005,  and  through  March 2007 if the  shareholders  approve  the
recapitalization transaction. In the event that shareholders fail to approve the
recapitalization  transaction or the recapitalization transaction fails to occur
for any other reason, the Company's secured obligations (including the Company's
mandatorily redeemable preferred stock), which exceeds $13.6 million as of March
30, 2004, will be due and payable on June 1, 2005.

The following summarizes the Company's significant  contractual  obligations and
commitments  that  impact its  liquidity  as of December  31, 2003 after  giving
effect to March 30, 2004 financing agreement.

<TABLE>
<CAPTION>
Contractual Obligations                                         Payments Due by Period
-------------------------------------------------------------------------------------------------------------
                                                         Less than       1 - 3           4 - 5         After
(thousands)                                Total          1 year         years           years        5 years
-------------------------------------------------------------------------------------------------------------

<S>                                       <C>            <C>            <C>            <C>            <C>
Notes payable                             $ 7,989                       $ 7,989
Redeemable preferred stock                  3,800                         3,800
Interest payable                              486                           486
Executive insurance agreement                 408                            50        $   100        $   258
Capital leases                                319        $    94            225
Operating leases                            2,476            442          1,723            104            207
                                          -------------------------------------------------------------------
Total contractual cash obligations        $15,478        $   536        $14,273        $   204        $   465
                                          ===================================================================
</TABLE>


Operating  activities  provided $3 million of cash in 2003 compared to using $.2
million in 2002.  The non-cash  expenses in 2003 were $2.2  million  compared to
$2.5 million in 2002. 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  $.5 million from
December  31,  2002.  The  increase is due to the  increase in revenue  from the
fourth  quarter of 2002 of $6.4 million to revenue of $8.5 million in the fourth
quarter of 2003.


                                       23
<PAGE>


Total  inventories  decreased  $1.9  million  from  2002  levels.  Manufacturing
inventories  decreased  $1.5  million  during  the  year  due to a  decrease  in
materials and component parts of $1.2 million and a decrease in  work-in-process
inventory of $.3 million.  Finished goods  inventory  remained  consistent  with
prior year levels.  The decrease in materials and component  parts is mainly due
to a decrease in the production schedule for the first quarter of 2004 and lower
production  costs  of the new SO  series  scanner.  Customer  service  inventory
decreased  for the year by $.4  million,  which was mainly  attributable  to the
amortization of spare parts inventory.

Net plant and  equipment  decreased  $.3 million in 2003.  This net  decrease is
mainly due to  depreciation  of $.4 million which was offset by additions of $.2
million.  During the year the Company  conducted a physical  inventory  of fixed
assets and as a result $6.5 million in asset value and accumulated  depreciation
of $6.4  million  were  written  off  resulting  in a loss on  disposals  of $.1
million.

Goodwill  remained  consistent with prior year. 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 remained consistent with the prior year.

Notes  payable  to bank  decreased  $2.6  million  due to pay down of the  notes
payable during the year. (See Note G.)

Salaries and wages  increased  $.5 million from 2002 mainly due to a $.5 million
increase in bonus accrual.

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

Customer  deposits  decreased $.4 million due mainly to two large orders in 2002
that contained deposit requirements as part of the contract.

Other  current  liabilities  decreased $.2 million due mainly to a decrease in a
tax contingency reserve of $.3 million, decrease of $.1 million in accrued legal
fees  partially   offset  by  a  $.2  million   increase  in  VAT  reserves  and
miscellaneous accruals in the UK operations.

Other long term  liabilities  increased  $.2 million  mainly due to accruals for
lease  payments that were deferred as part of the March 2004 debt  restructuring
and  will  mature  on  June 1,  2005,  and  accrued  interest  on the  mandatory
redeemable preferred stock.


                                       24
<PAGE>


OTHER MATTERS

New Accounting Standards

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

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

Inventories - slow moving and obsolete:  The Company performs regular reviews 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.  The spare  parts  are  amortized  over four  years and the
reserves are reviewed periodically for appropriateness.


                                       25
<PAGE>


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 going forward it will be tested on at least
an annual basis for impairment, see Note C.


                                       26
<PAGE>


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

On March 30,  2004,  the  Company  completed  a total  debt  restructuring  (see
"Liquidity and Capital Resources" for further information); however, the Company
remains  highly  leveraged  and could be  adversely  affected  by a  significant
increase  in  interest  rates.  A one  percent  increase in the prime rate would
increase the annual  interest cost on the  outstanding  loan balance at December
31, 2003 of approximately $8 million by $.1 million.

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

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



                                       27
<PAGE>


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




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

As discussed in Note B, the consolidated financial statements for 2002 have been
restated due to a change in the  application  of generally  accepted  accounting
principles relating to the adjustment of certain liabilities.

As discussed in Note C to the  consolidated  financial  statements,  in 2002 the
Company changed its method of accounting for goodwill.

                                                           /s/ Ernst & Young LLP

Hartford, Connecticut
March 26, 2004, except for Note G,
as to which the date is March 30, 2004


                                       29
<PAGE>


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

<TABLE>
<CAPTION>
                                                                     December 31
(thousands, except share data)                                   2003           2002
------------------------------------------------------------------------------------
                                                                            Restated
<S>                                                           <C>            <C>
Assets
Current Assets:
  Cash and cash equivalents                                   $   585        $   274
  Accounts receivable less allowance of $1,134 in 2003
                  and $1,574 in 2002                            6,043          5,554
  Unbilled receivables - contracts in progress                    415            377
  Inventories                                                   7,282          9,139
  Prepaid expenses and other                                      597            591
                                                              ----------------------
    Total current assets                                       14,922         15,935


Plant and Equipment:
  Equipment                                                     3,682          8,836
  Leasehold improvements                                        4,010          5,209
  Office furniture and fixtures                                   745            725
                                                              ----------------------
                                                                8,437         14,770
  Less allowances for depreciation and amortization             7,422         13,456
                                                              ----------------------
                                                                1,015          1,314



Goodwill                                                        9,040          9,040
Other assets                                                    1,096            117
                                                              ----------------------

Total Assets                                                  $26,073        $26,406
                                                              ======================
</TABLE>


                                       30
<PAGE>


<TABLE>
<CAPTION>
                                                                          December 31
(thousands, except share data)                                       2003             2002
------------------------------------------------------------------------------------------
                                                                                  Restated
<S>                                                              <C>              <C>
Liabilities and Stockholders' Equity
Current liabilities:
  Accounts payable                                               $  2,323         $  2,274
  Note payable                                                                       1,500
  Salaries and wages                                                1,484            1,027
  Taxes other than income taxes                                       758              501
  Income taxes                                                        189               45
  Deferred revenue                                                  2,787            2,217
  Customer deposits                                                   929            1,308
  Other                                                             1,495            1,669
                                                                 -------------------------
    Total current liabilities                                       9,965           10,541

  Notes payable                                                     7,989            9,042
  Other liabilities                                                 1,876            1,640

  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 2003 and 2002                                         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                           (32,570)         (33,556)
  Accumulated other comprehensive loss                               (844)            (918)
                                                                 -------------------------
                                                                    5,089            4,029
  Less cost of common stock in treasury,
    413,500 shares                                                  2,646            2,646
                                                                 -------------------------
      Total stockholders' equity                                    2,443            1,383
                                                                 -------------------------
  Total Liabilities and Stockholders' Equity                     $ 26,073         $ 26,406
                                                                 =========================
</TABLE>

See accompanying notes


                                       31
<PAGE>


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

<TABLE>
<CAPTION>
                                                               Year Ended December 31
(thousands, except share data)                           2003                2002               2001
----------------------------------------------------------------------------------------------------
                                                                         Restated
<S>                                               <C>                 <C>                <C>

Revenues
         Hardware and software                    $    16,044         $    11,292        $    11,195
         Professional services                          5,474               6,550              6,352
         Access services                               10,563              11,499             13,193
                                                  --------------------------------------------------
                  Total revenues                       32,081              29,341             30,740

Costs of Revenue
         Hardware and software                         10,690               7,816              9,331
         Professional services                          2,717               2,899              3,967
         Access services                                8,813               8,539             11,200
                                                  --------------------------------------------------
                  Total costs of revenues              22,220              19,254             24,498

                                                        9,861              10,087              6,242
Gross Margin

Operating Expenses
         Sales and marketing                            3,455               3,273              3,914
         Research and development                       1,267               1,798              2,936
         General and administrative                     3,572               3,566              3,899
         Interest                                         856                 846              1,788
                                                  --------------------------------------------------
                  Total costs and expenses              9,150               9,483             12,537
                                                  --------------------------------------------------

Operating income (loss)                                   711                 604             (6,295)

Other income, net                                         133                 419                 15
                                                  --------------------------------------------------

Income (loss) before income taxes                         844               1,023             (6,280)

         Income tax expense (benefit)                    (142)                 81                 33
                                                  --------------------------------------------------

Net Income (Loss)                                 $       986         $       942        $    (6,313)
                                                  ==================================================

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

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

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

Diluted weighted-average shares                     7,806,491           7,317,437          7,026,232
</TABLE>

See accompanying notes.


                                       32
<PAGE>


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

<TABLE>
<CAPTION>
                                                                                Accumulated  Accumulated
                                             Common Stock         Capital in     Retained-     Other
                                        ----------------------     Excess of     Earnings   Comprehensive  Treasury
(thousands, except share data)            Shares       Amount      Par Value      Deficit    Income (Loss)   Stock         Total
-----------------------------------------------------------------------------------------------------------------------------------

<S>                                     <C>            <C>         <C>           <C>            <C>        <C>           <C>
Balance January 1, 2001                 7,439,732      $ 149       $ 35,654      $ (28,185)     $ (665)    $ (2,646)     $ 4,307

Issuance of common stock
  upon exercise of stock
  options                                                             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

Issuance of common stock
  warrants
Net income (restated)                                                                  942                                   942
Currency translation
  adjustments                                                                                       81                        81
                                                                                                                         --------
Comprehensive income
  (restated)                                                                                                               1,023
---------------------------------------------------------------------------------------------------------------------------------

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

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

Balance December 31, 2003               7,439,732      $ 149       $ 38,354      $ (32,570)     $ (844)    $ (2,646)     $ 2,443
=================================================================================================================================
</TABLE>

See accompanying notes.



                                                               33
<PAGE>


SCAN-OPTICS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31
(thousands)                                                                     2003             2002             2001
-----------------------------------------------------------------------------------------------------------------------
Operating Activities                                                                          Restated
<S>                                                                         <C>              <C>              <C>
         Net income (loss)                                                  $    986         $    942         $ (6,313)
                  Adjustments to reconcile net income (loss) to net
                       cash provided (used) by operating activities:
                  Depreciation                                                   426              425              677
                  Amortization of customer service inventory and
                         software license                                      1,885            2,355            2,886
                  Amortization of goodwill                                                                       1,326
                  Provision for losses on accounts receivable                     22               35
                  Provision for inventory obsolescence                                             50              178
                  Reversal of previously recorded liabilities                   (183)            (369)
                  Changes in operating assets and liabilities:
                         Accounts receivable                                    (549)            (668)           6,507
                         Refundable income taxes                                                                   124
                         Inventories                                             (28)          (2,634)          (1,873)
                         Prepaid expenses and other                               (6)             (87)             465
                         Software license
                         Accounts payable                                        232             (819)          (2,604)
                         Accrued salaries and wages                              457             (353)             526
                         Taxes other than income taxes                           257              (23)             131
                         Income taxes                                            144               40             (116)
                         Deferred revenue                                        570              116               24
                         Customer deposits                                      (379)             801             (705)
                         Other                                                  (797)              21             (330)
                                                                            -------------------------------------------
                Net cash provided (used) by operating activities               3,037             (168)             903

Investing Activities
         Acquisition related settlement                                                           209              400
         Proceeds from the sale of plant and equipment                                             35
         Purchases of plant and equipment, net                                  (173)            (114)             (64)
                                                                            -------------------------------------------
                Net cash provided (used) by investing activities                (173)             130              336

Financing Activities
         Proceeds from issuance of common stock
         Proceeds from borrowings                                              7,650            4,376            3,485
         Principal payments on borrowings                                    (10,203)          (5,726)          (3,098)
                                                                            -------------------------------------------
                Net cash provided (used) by financing activities              (2,553)          (1,350)             387

Increase (decrease) in cash and cash equivalents                                 311           (1,388)           1,626
Cash and Cash Equivalents at Beginning of Year                                   274            1,662               36
                                                                            -------------------------------------------
Cash and Cash Equivalents at End of Year                                    $    585         $    274         $  1,662
                                                                            ===========================================

Supplemental Cash Flow Information
Interest paid                                                               $    732         $    667         $  1,579
                                                                            ===========================================
Income taxes paid                                                           $     24         $     44         $     61
                                                                            ===========================================
</TABLE>
See accompanying notes.


                                                           34
<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  factors  include  (1) the  effect  of a  continued
weakening in the domestic and international economies, which potentially impacts
capital  investments  by customers,  (2) the cyclical  nature of funding  within
federal and state government  agencies,  (3) competition from similar  products,
(4) the  implementation  of other  technologies,  which may provide  alternative
solutions to customers, and (5) the stability of sole source suppliers.


NOTE B - RESTATEMENT OF 2002 CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE C - 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.

Use of Estimates:  The  preparation of financial  statements in conformity  with
accounting   principles   generally  accepted  in  the  United  States  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.

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


                                       35
<PAGE>

year to year have been  reported in  accumulated  other  comprehensive  loss,  a
component of Stockholders' Equity.

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

Accounts  Receivable  and  Revenue  Recognition:  Revenues  relating to sales of
certain  equipment  (principally  optical character  recognition  equipment) are
recognized upon acceptance,  shipment, or 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  (Note O). When right of return  exists,
the Company recognizes  revenue in accordance with SFAS 48, Revenue  Recognition
When Right of Return Exists.

Revenues  under systems  integration  and  professional  services  contracts are
recognized on a proportionate  performance  basis,  based on the ratio of earned
revenue  to total  contract  price,  after  considering  accumulated  costs  and
estimated  costs to complete each contract or when services have been  performed
and accepted,  depending on the nature of the  individual  project.  Under fixed
price contracts, the Company may encounter, which has been the case with certain
contracts in prior years,  cost overruns caused by project  management  problems
and the expense of hiring outside contractors to assist in project  completions,
as well as changes to previously  agreed upon project  designs.  Adjustments  to
contract  cost  estimates  are made in the periods in which the facts  requiring
such revisions become known. When the estimates  indicate a loss on a particular
contract, such a loss is provided for in the period it is identified.

Revenues from maintenance  services are recognized when the related services are
provided.

The  Company  generally   records   receivables  when  the  related  revenue  is
recognized.  Based on certain  pre-negotiated  contract  terms  billing  may not
coincide with revenue recognition, in which case, amounts due from customers are
captured  in unbilled  receivables  until the  customer is actually  invoiced in
accordance with the contract terms.

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

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. The spare parts are amortized over four years and the reserves are
reviewed periodically for appropriateness.

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

Long-Lived Assets: Long-lived assets are recorded at the lower of amortized cost
or  fair  value.   Software   license  acquired  in  1999  was  amortized  on  a
straight-line basis over 3 years.


                                       36
<PAGE>


Asset  Impairment:  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
non-discounted  cash flow analysis over the remaining  useful life of the asset,
the carrying value would be reduced to its estimated fair value. There have been
no material impairments recognized in these financial statements.

Goodwill:  Goodwill  consists  of the  excess  of cost  over the  fair  value of
identifiable  net assets of  businesses  acquired.  As of  January 1, 2002,  the
Company adopted Financial Accounting Standards Board Statement No. 142, Goodwill
and Other Intangible Assets (FAS 142) and as such no longer amortizes  goodwill,
but rather tests it annually for impairment. There was no impairment of goodwill
at January 1, 2003 or January 1, 2002.  Had  Statement No. 142 been in effect as
of the beginning of 2001,  amortization  expense for the year ended December 31,
2001 would have been reduced by $1,326,000, reducing net loss by the same amount
and reducing net loss per share by $.19 per share.

Capitalized Software Development Costs: The Company capitalizes certain internal
and external costs in accordance with FASB Statement No. 86,  Accounting for the
Costs of Software to be Sold, Leased, or Otherwise Marketed  associated with the
development of certain  software.  These costs are amortized on a  straight-line
basis over the  estimated  useful life of the software or on a units sold basis,
whichever  results in the  shorter  amortization  period.  Capitalized  software
totaled $960,000 at December 31, 2003. No costs were capitalized at December 31,
2002.

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, 2003 and 2002 and approximate the carrying value
of these financial instruments.

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

Advertising  Costs: The Company expenses the production costs of advertising the
first time the  advertising  takes place.  Advertising  costs  ($10,000 in 2003,
$12,000  2002,  and  $9,000  in 2001)  are  included  in  selling,  general  and
administrative expenses.

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


                                       37
<PAGE>

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

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

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



<TABLE>
<CAPTION>
                                                                           December 31
     (thousands, except per share amounts)                      2003            2002            2001
     -------------------------------------------------------------------------------------------------
                                                                             Restated
<S>                                                        <C>             <C>             <C>
     Net income (loss), as reported                        $     986       $     942       $  (6,313)
     Deduct: Stock option expense                                (93)           (199)           (134)
                                                           -------------------------------------------
     Pro forma net income (loss)                           $     893       $     743       $  (6,447)
                                                           ===========================================

     Basic earnings (loss) per share, as reported          $     .14       $     .13       $    (.90)
     Stock option expense                                       (.01)           (.03)           (.02)
                                                           -------------------------------------------
     Pro forma basic earnings (loss) per share             $     .13       $     .10       $    (.92)
                                                           ===========================================

     Diluted earnings (loss) per share, as reported        $     .13       $     .13       $    (.90)
     Stock option expense                                       (.01)           (.03)           (.02)
                                                           -------------------------------------------
     Pro forma diluted earnings (loss) per share           $     .12       $     .10       $    (.92)
                                                           ===========================================
</TABLE>


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 1.102.

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.


                                       38
<PAGE>


Earnings  (Loss)  Per  Share:  Basic and  diluted  earnings  (loss) per share is
calculated in accordance with FASB Statement No. 128, Earnings Per Share.

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.

New Accounting Pronouncements:
On January 1, 2003, the Company adopted the Financial Accounting Standards Board
("FASB")  Statement  of  Financial   Accounting   Standards  ("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.
Adoption of this standard did not have an impact on the  Company's  consolidated
financial  position,  at December 31, 2003 or results of operations for the year
then ended.

On January 1, 2003, the Company also adopted 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  did  not  have  an  impact  on the  Company's  consolidated  financial
position, at December 31, 2003 or results of operations for the year then ended.

In May 2003,  the FASB  issued SFAS No. 150,  Accounting  for Certain  Financial
Instruments  with  Characteristics  of both Liabilities and Equity ("SFAS 150").
This  statement  establishes   standards  for  classifying  and  measuring,   as
liabilities, certain financial instruments that embody obligations of the issuer
and have  characteristics  of both  liabilities  and equity.  SFAS 150 generally
requires   liability   classification  for  financial   instruments,   including
mandatorily  redeemable  equity  instruments  and other  non-equity  instruments
requiring,  from  inception,  the repurchase by the issuer of its equity shares.
This  statement was applicable to the Company  effective  September 1, 2003. The
adoption of this  Statement did not have a  significant  effect on the Company's
financial  position as of December 31, 2003 or on the results of operations  for
the year then ended.

In May 2003,  the FASB's  Emerging  Issues Task Force defined the scope of Issue
00-21,  Revenue  Arrangements With Multiple  Deliverables ("EITF No. 00-21") and
its interaction with other authoritative  literature.  The statement was adopted
by the Company  effective  September 1, 2003 and requires  revenue  arrangements
including multiple  deliverables to be divided into separate units of accounting


                                       39
<PAGE>

for revenue  recognition  purposes,  if the deliverables in the arrangement meet
certain  criteria,  including  standalone  value to the customer,  objective and
reliable  evidence of the fair value of the undelivered  items exists and if the
arrangement  includes a general right of return  relative to the delivered item,
delivery or  performance  of the  undelivered  item is  considered  probable and
substantially  in the control of the vendor.  The adoption of this Statement did
not have a significant effect on the Company's financial position as of December
31, 2003 or on the results of operations for the year then ended.

In December 2003, the FASB issued SFAS  Interpretation No. 46,  Consolidation of
Variable Interest  Entities,  an Interpretation of ARB No. 51, which effectively
modified and clarified certain  provisions of FIN 46, as originally  issued. The
Company is required to adopt the  provisions  of this  guidance  for the quarter
ending March 31, 2004, as it relates to all variable interests held, except that
adoption  is required by December  31, 2004 for all  variable  interest  held in
entities that are  considered to be special  purpose  entities.  The adoption of
this Statement did not have a significant  effect on the Company's  December 31,
2003 financial  statements and is not expected to have a significant impact upon
adoption in the first  quarter of 2004.  The  Company  has no variable  interest
entities.



NOTE D - Acquisition Activities

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.


NOTE E - UNBILLED RECEIVABLES - CONTRACTS IN PROGRESS

Unbilled  amounts in accounts  receivable  under  contracts in progress were $.4
million at December 31, 2003 and 2002,  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 2004.


                                       40
<PAGE>



NOTE F - INVENTORIES

The components of inventories were as follows:

                                          December 31
(thousands)                            2003          2002
---------------------------------------------------------
Finished goods                       $   57        $   56
Work-in-process                       1,066         1,325
Service parts                         3,291         3,715
Materials and component parts         2,868         4,043
                                     --------------------
                                     $7,282        $9,139
                                     ====================


NOTE G - 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 as of December  31,  2003.  At  December  31,  2003,  the Company had $8
million in outstanding  borrowings,  all of which are classified as long-term as
the Company has refinanced the notes on a long-term basis. The available balance
on the outstanding  borrowings was $3.6 million and $1.5 million at December 31,
2003 and December 31, 2002, respectively.  The weighted average interest rate on
borrowings during 2003 and 2002 was 4.8% and 5.5%, respectively.

     Effective March 30, 2004, the Company  entered into a new credit  agreement
with lenders  affiliated with Patriarch  Partners,  LLC. (the  "Lenders")  that,
among other  things,  extends  from  December  31, 2004 through June 1, 2005 the
repayment  date for all of the  Company's  secured debt and provides  additional
working  capital  in the amount of $1.5  million.  Subject  to  approval  by the
shareholders at the Company's  Annual Meeting  scheduled to be held on or before
July 1, 2004,  the Company will issue to the Lenders 79.8% of the  fully-diluted
Common  Stock of the  Company in  consideration  for,  among other  things,  the
Lenders'  agreement to extend the repayment  date for  outstanding  secured debt
through March 30, 2007. More specifically,  the financing  arrangement  includes
the following items:

     o The  Company's  secured term and  revolving  debt is  exchanged  for a $9
million  term loan.  The new term loan is  payable in annual  amounts of $90,000
beginning  March  2005 with the  balance  due at  maturity.  A new $2.5  million
revolving  credit  facility  is also  provided,  which  can be used for  working
capital and other general business purposes.  Borrowings against both such loans
will  continue to accrue  interest at a rate of prime plus 2%. The maturity date
for these loans is extended from December 31, 2004 to June 1, 2005.

     o An additional  $1.5 million working capital term loan is available to the
Company,  with the Company  obligated to repay $2 million at maturity on June 1,
2005.  The working  capital term loan will accrue  interest on $2 million at the
prime rate.

     o The  Company's  financial  covenants  with  respect to  backlog,  capital
expenditure  and EBITDA have been modified to enhance the financial  flexibility
of the Company.


                                       41
<PAGE>



     o The Company has exchanged the $3.8 million mandatorily  redeemable Series
A preferred stock held by the Lenders for $3.8 million of mandatorily redeemable
Series B preferred stock,  which Series B preferred stock has  substantially the
same terms as the Series A, except  that the  redemption  date is extended  from
December 31, 2004 to June 1, 2005.

     o The Company has agreed to use its best efforts,  subject to the fiduciary
duties of the Board of Directors,  to complete a recapitalization of the Company
by July 1, 2004. The Lenders  currently  hold both the Series B preferred  stock
noted  above and a warrant to  purchase  common  stock  issued to the Lenders in
December  2001  currently  valued at $2.7  million.  The Lenders are entitled to
exercise the warrant, upon the earlier of January 1, 2005 or a triggering event,
for 33.2% of the fully-diluted common stock of the Company at $.02 per share. In
addition,  upon the  Lender's  exercise of the  warrant,  the Series B preferred
would be  entitled  to vote with the common  stock and would have  46.67% of the
voting power of the Company, on a fully-diluted basis. The recapitalization will
include,  among other terms,  the  cancellation of the $3.8 million  mandatorily
redeemable Series B preferred stock and the existing  warrant,  and the issuance
of common stock of the Company to the Lenders so that  following  such  issuance
the Lenders  will own 79.8% of the  fully-diluted  common  stock of the Company,
subject to dilution for certain  current and future  compensatory  stock options
issued by the Company.  The  recapitalization  is subject to the approval by the
stockholders of the Company of an amendment to the certificate of  incorporation
of the  Company to  increase  the  authorized  common  stock of the  Company and
related matters,  which approval will be sought at the Company's  planned annual
meeting to be held on or before July 1, 2004.

     o Upon  approval  by the  Company's  shareholders  of the  recapitalization
described above, the maturity date for all of the Company's secured indebtedness
to the Lenders will be further extended from June 1, 2005 to March 30, 2007.

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

NOTE H - 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, 2003
and  2002,   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, 2003, 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 G.)

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, 2003 and 2002.


                                       42
<PAGE>



NOTE I - STOCK OPTION PLANS

The Company has six stock  option  plans for key  employees  and board  members.
Options  granted under the plans are for a period of ten years and at prices not
less than 85% of the fair market  value of the shares at date of grant.  Options
for employees are not  exercisable  for one year following the date of grant and
then are exercisable in such installments during the period prior to expiration,
as the Stock  Option  and  Executive  Compensation  Committee  shall  determine.
Options for senior  management that were granted on December 31, 2001 as part of
the total debt  restructuring  are not  exercisable  until six months  after the
grant thereof.  Options for Directors are also not exercisable  until six months
after the grant thereof.  Options may be exercised from time to time, in part or
as a whole,  on a  cumulative  basis  as  determined  by the  Stock  Option  and
Executive Compensation Committee under all stock option plans.

The following  schedule  summarizes the changes in stock options for each of the
three years in the period ended December 31, 2003:

<TABLE>
<CAPTION>
                                                                             Weighted
                                                              Number of       Average               Option Price
                                                                Shares         Price                 Per Share
------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>               <C>          <C>                   <C>
Outstanding January 1, 2001 (545,245 exercisable)             1,122,133         $2.56        $ .31       to        $9.19
         Granted                                              1,145,000           .24          .24       to          .25
         Canceled                                               (69,050)          .72          .31       to         3.69
                                                             -----------------------------------------------------------
Outstanding December 31, 2001 (782,261 exercisable)           2,198,083          1.41          .24       to         9.19

2002 Activity
-------------
         Granted                                                 30,000           .34          .34       to          .34
         Canceled                                              (236,800)         1.65          .24       to         9.19
                                                             -----------------------------------------------------------
Outstanding December 31, 2002 (1,869,142 exercisable)         1,991,283          1.37          .24       to         9.19

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


<TABLE>
<CAPTION>
                                                 Options Outstanding                               Options Exercisable
------------------------------------------------------------------------------------------------------------------------------------
                                                       Weighted
                                                        Average           Weighted
                                                       Remaining           Average                                     Weighted
                                    Number            Contractual          Exercise          Number                    Average
Range of Exercise Prices         Outstanding          Life (Years)          Price          Exercisable               Exercise Price
-----------------------------------------------------------------------------------------------------------------------------------
<C>                               <C>                     <C>                  <C>           <C>                          <C>
$  .24 to $  .60                  2,095,600               8                  $ .27           1,413,100                  $ .27
$  .61 to $1.50                      87,500               6                   1.06              87,500                   1.06
$1.51 to $3.75                      271,583               4                   3.36             271,583                   3.36
$3.76 to $9.19                      198,000               3                   6.10             198,000                   6.10
-----------------------------------------------------------------------------------------------------------------------------------
                                  2,652,683                                                  1,970,183

</TABLE>



                                       43
<PAGE>

At December 31, 2003 there were  200,272  options  available  for grant of which
71,500 were reserved for the Directors.

The  weighted-average  fair value of options  exercisable  was $1.31,  $1.43 and
$3.32 at December 31, 2003, 2002, and 2001,  respectively.  The weighted-average
remaining contractual life of the options outstanding at December 31, 2003 was 7
years.



NOTE J - RESEARCH AND DEVELOPMENT AGREEMENTS

During  2003,  2002 and 2001,  the Company  completed  a number of small  custom
development   contracts   for  specific   customers   resulting  in  revenue  of
approximately  $200,000,  $43,000 and  $410,000,  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 K - 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,  $346,000 and
$254,000, in 2003, 2002 and 2001, respectively.

The Company  sponsors an Employee  Stock  Ownership  Plan (the "Plan")  covering
substantially  all  full-time  employees.  The  Plan,  which is a tax  qualified
employee  benefit plan,  was adopted by the Board of Directors of the Company in
1988 to provide retirement benefits for employees.  The Plan borrowed $1,325,000
to  purchase   260,000  shares  of  the  Company's  stock  to  be  allocated  to
participants ratably 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 2003,  2002 or 2001.  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 2003, 2002 and 2001.

The Company  terminated the ESOP plan effective December 31, 2003. There will be
no significant financial impact to the Company.



                                       44
<PAGE>


NOTE L - INCOME TAXES

At December  31, 2003,  the Company has U.S.  federal and state  operating  loss
carryforwards of approximately $ 27,700,000 and  $25,500,000,  respectively.  At
December  31,  2002,  the Company  has U.S.  federal  and state  operating  loss
carryforwards of approximately  $27,000,000 and $26,000,000,  respectively.  The
U.S. federal and state net operating loss carryforwards expire from 2004 through
2014.  At  December  31,  2003,  the Company has  approximately  $3,600,000  and
$800,000 of net operating loss carryforwards for the United Kingdom and Germany,
respectively.  There are no net  operating  loss  carryforwards  for Canada.  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,  which  expire from 2004  through  2009.  For  financial
reporting purposes, a valuation allowance has been recorded for 2003 and 2002 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)                                   2003             2002             2001
-------------------------------------------------------------------------------------
                                                            Restated
<S>                                        <C>              <C>              <C>
Domestic                                   $   708          $   811          $(6,270)
Foreign                                        136              212              (10)
                                          -------------------------------------------
Income (loss) before income taxes          $   844          $ 1,023          $(6,280)
                                          ===========================================
</TABLE>


Income taxes (benefit) are summarized as follows:

                                  Year Ended December 31
(thousands)                 2003            2002           2001
---------------------------------------------------------------
Current :
  State                    $  40           $  80          $  28
  Federal benefit           (321)
  Foreign                    139               1              5
                          -------------------------------------
Total current              $(142)          $  81          $  33
                          -------------------------------------

   Deferred
                          -------------------------------------
Total                      $(142)          $  81          $  33
                          =====================================


                                       45
<PAGE>


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

<TABLE>
<CAPTION>
                                                                  December 31
(thousands)                                                 2003               2002
------------------------------------------------------------------------------------
<S>                                                     <C>                <C>
 Deferred tax assets:
   Net operating loss carryforward                      $ 12,109           $ 11,936
   Alternative minimum tax credit carryforward               168                168
   Depreciation                                               92                 92
   Charitable contribution carryforward
   Inventory                                                 584                673
   Bonus                                                      26                 26
   Accounts receivable allowance                             354                538
   Goodwill                                                                     119
   Vacation accrual                                          183                172
   Other                                                     109                155
                                                      -------------------------------
      Total gross deferred tax assets                     13,625             13,879

Deferred tax liabilities:
Goodwill                                                    (175)
Depreciation and other                                      (151)              (306)
                                                      -------------------------------
      Total gross deferred tax liabilities                  (326)              (306)

Valuation allowance                                      (13,299)           (13,573)
                                                      -------------------------------
      Net deferred tax asset                            $     --           $     --
                                                      ===============================
</TABLE>

A  reconciliation  of the statutory taxes to the provision  (benefit) for income
taxes is as follows:


<TABLE>
<CAPTION>
                                                            Year Ended December 31
                                                        2003         2002             2001
------------------------------------------------------------------------------------------
<S>                                                       <C>          <C>             <C>
Federal income taxes at statutory rate                   $287          $348        $(2,135)
       State income taxes, net of federal benefit          66            80             28

       Foreign income taxes                                93
       Valuation allowance, net of deferred
          tax adjustments                                (382)         (348)         2,135
       Adjustment of tax reserves                        (206)
Other                                                                     1              5
                                                     -------------------------------------
Provision (benefit) for income taxes                   $(142)           $81            $33
                                                     =====================================
</TABLE>

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

                                       46
<PAGE>


NOTE M - 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, 2003, are as follows:


<TABLE>
<CAPTION>
(thousands) Operating Leases Capital Lease

<S>                                                      <C>                  <C>
     2004                                                $   442              $     94
     2005                                                  1,228                    84
     2006                                                    443                    74
     2007                                                     52                    67
     2008                                                     52
     Thereafter                                              259
                                                           ----------------------------
     Total minimum lease payments                        $ 2,476                   319
                                                         =======
     Amounts representing interest                                                 (62)
                                                                              ---------
     Present value of net minimum lease payments                              $    257
                                                                              ========
</TABLE>


Rental  expense  for the years  ended  December  31,  2003,  2002,  and 2001 was
$470,000, $681,000 and $718,000, respectively.

The  amount of gross  assets  recorded  under  capital  lease  arrangements  and
accumulated  depreciation  thereon totaled $322,000 and $43,000, at December 31,
2003 and a gross asset value of $280,000 at December 31, 2002. All leased assets
are  classified  as equipment.  Amortization  of assets  recorded  under capital
leases is included in depreciation expense.

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


NOTE N - CONTINGENCIES

Since 2001, an action has been pending against Scan-Optics alleging, among other
things,  breach of contract in  connection  with a contract  for the delivery of
hardware,  software  and  professional  services.  Scan-Optics  has  denied  the
material  allegations of the complaint and counterclaimed for breach of contract
and seeks recovery of unpaid  receivables,  totaling $1.4 million.  Although the
ultimate  outcome is  uncertain,  based on currently  known  facts,  the Company
believes  that it has strong  defenses  against the lawsuit and valid claims for
recovery  for the net amount of unpaid  receivables  recorded  in the  financial
statements,  and that the  resolution  of this  matter  will not have a material
adverse effect on the Company's financial position or annual operating results.


                                       47
<PAGE>


NOTE O - 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)                                                      2003            2002            2001
-----------------------------------------------------------------------------------------------------
                                                                             Restated
<S>                                                          <C>             <C>             <C>
Revenues
  Solutions and products                                     $ 21,108        $ 16,376        $ 16,667
  Access services                                              10,563          11,499          13,193
  Contract manufacturing services                                 410           1,466             880
                                                           ------------------------------------------
    Total revenues                                             32,081          29,341          30,740

Cost of solutions and products                                 13,407          10,715          13,298
Service expenses                                                8,813           8,539          11,200
                                                           ------------------------------------------

    Gross profit margin                                         9,861          10,087           6,242

  Operating expenses, net                                       9,017           9,064          12,522

                                                           ------------------------------------------
Income (loss) before income taxes                            $    844        $  1,023        $ (6,280)
                                                           ==========================================

Total assets                                                 $ 26,073        $ 26,406        $ 27,380

Total expenditures for additions to long-lived assets        $    173        $     79        $    121
</TABLE>


The Company  restated the 2002  consolidated  financial  statements to reflect a
change in the application of generally accepted  accounting  principles relating
to certain liabilities.  The net impact of this change increased 2002 net income
before taxes by $111,000 from the amount previously reported. Refer to Note B of
the consolidated financial statements for more details.

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

In 2003,  the  Company  derived  23% of its  total  revenue  from one  customer,
Northrop Grumman, IT Inc. In 2002 and 2001, no customers accounted for more than
10% of total revenue.


                                       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)            2003                          2002                          2001
------------------------------------------------------------------------------------------------------

<S>                  <C>                <C>        <C>                <C>        <C>                 <C>
Latin America        $  124             12%        $   72             24%        $  152              3%
Europe                                   0%           149             49%         3,706             73%
Pacific Rim             944             88%            81             27%         1,225             24%
                   -----------------------------------------------------------------------------------
                     $1,068                        $  302                       $5,083
                   ===================================================================================
</TABLE>


Export sales  represented 5%, 2%, and 30% of the Solutions and Products  Segment
revenues  for  the  three  years  ended  December  31,  2003,  2002,  and  2001,
respectively.  There are no exports  sales  derived  from the  Company's  Access
Services Segment or Contract Manufacturing Services Segment.


NOTE P - 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 2003, 2002, and 2001 included bill and hold transactions of $2.3 million,
$1.3 million and $.1 million,  respectively.  Accounts  receivable included bill
and hold  receivables  of $1.1  million and $.1 million at December 31, 2002 and
2001,  respectively.  There were no  receivables  associated  with bill and hold
transactions at December 31, 2003.


                                       49
<PAGE>


NOTE Q - 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)                                   2003               2002               2001
-----------------------------------------------------------------------------------------------------------
                                                                                Restated
<S>                                                       <C>                <C>                <C>
Numerator:
         Net earnings (loss)                              $       986        $       942        $    (6,313)
                                                          =================================================

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

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

         Denominator for diluted earnings (loss)
              Per share (adjusted weighted-average
              Shares and assumed conversions)               7,806,491          7,317,437          7,026,232

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

Diluted earnings (loss) per share                         $       .13        $       .13        $      (.90)
                                                          =================================================
</TABLE>


For the  year  ended  2001,  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 R - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly  results of operations for the years
ended December 31, 2003 and 2002.

<TABLE>
<CAPTION>
(thousands, except per share amounts)              March         June      September       December
---------------------------------------------------------------------------------------------------

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

2002                                                                        Restated      Restated
----
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           330           228
Basic earnings per share                             .02           .03           .02           .03
Diluted earnings per share                        $  .02        $  .03        $  .02        $  .03
</TABLE>



Fourth  quarter  2003 net income of $.6  million  includes a tax  benefit of $.2
million or $.03 per share due to a reduction in the tax reserves.

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.  Fourth  quarter  2002 net income
includes an adjustment  to reduce  operating  expenses by $.1 million  offset by
additional expense of $.1 million for bonus compensation.

Third quarter 2002 net income of $.3 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.
Third quarter 2002 net income has been restated from amounts previously reported
to reflect an increase income for the reduction in a liability of $.1 million or
$.01 per share.


                                       51
<PAGE>


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


None.




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

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


                                       52
<PAGE>


                                    PART III

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

Information  pertaining to Directors and  additional  information  pertaining to
Executive  Officers is included  under the captions  "Governance of the Company"
and  "Compliance  with Section 16(a) of the Securities  Exchange Act of 1934" in
the Company's  definitive  proxy statement to be filed under  Regulation 14A for
the Annual Meeting of  Stockholders  presently  scheduled to be held on June 16,
2004 and is incorporated herein by reference and made a part hereof.

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       58       Chairman, Chief Executive Officer
                              and President                              1996

Joseph P. Crouch     41       Vice President -
                              Manufacturing Services Division            1999

Richard C. Goyette   52       Vice President -
                              Sales and Marketing                        1996

Richard D. Harris    43       Corporate Secretary                        2001

Joel K. Howser       56       Vice President -
                              Software Development                       1998

Clarence W. Rife     64       Vice President -
                              Access Services Division and
                              Hardware Engineering                       1975

Peter H. Stelling    53       Chief Financial Officer, Vice
                              President, Treasurer and                   2004
                              Assistant Corporate Secretary

Alan W. Ware         65       Vice President -
                              Project and System Integration             2000


                                       53
<PAGE>


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.

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


Mr.  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.


                                       54
<PAGE>


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

This  information is included in the Company's  definitive proxy statement to be
filed under  Regulation  14A for the Annual  Meeting of  Stockholders  presently
scheduled to be held on June 16, 2004 and is incorporated herein by reference.


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

For  information  with respect to the security  ownership of the  Directors  and
Executive Officers and related stockholders  matters, see the Proxy Statement to
be  filed  under  Regulation  14A for  the  Company's  2004  Annual  Meeting  of
Shareholders  presently  scheduled  to  be  held  on  June  16,  2004  which  is
incorporated by reference herein. The Company has six equity  compensation plans
as of  December  31,  2003.  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, 2003.


<TABLE>
<CAPTION>
                                                                                                   Number of shares of
                                                                                                 Common Stock remaining
                                                                                                  available for future
                                           Number of shares of                                    issuance under equity
                                        Common Stock to be issued        Weighted -average         compensation plans
                                            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                     1,627,683                       $1.56                     200,272

Equity compensation plans not
  approved by stockholders:
     Senior management options                 1,025,000                         .24
     Debt restructuring warrants               4,975,000                         .02
                                           ----------------------------------------------------------------------
                                               7,627,683                       $1.39                     200,272
                                           ======================================================================
</TABLE>


Equity  compensation  plans not  approved by  stockholders  include  options for
senior management and warrants issued to Patriarch,  which were both part of the
Company's  2001 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 G to
the Notes to Consolidated  Financial  Statements of the Company included in this
report for additional information.


                                       55
<PAGE>


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

This  information is included under the caption  "Certain  Transactions"  in the
Company's  definitive  proxy statement to be filed under  Regulation 14A for the
Annual  Meeting of  Stockholders  presently  to be held on June 16,  2004 and is
incorporated herein by reference.



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

This  information is included under the caption  "Principal  Accountant Fees and
Services" in the Company's  definitive  proxy  statement to be filed pursuant to
Regulation 14A for the Annual Meeting of Stockholders  presently scheduled to be
held on June 16, 2004 and is incorporated by reference.



                                       56
<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, 2003 and 2002

          Consolidated Statements of Operations for the years ended December 31,
          2003, 2002 and 2001

          Consolidated  Statements of  Stockholders'  Equity for the years ended
          December 31, 2003, 2002 and 2001

          Consolidated Statements of Cash Flows for the years ended December 31,
          2003, 2002 and 2001

          Notes to Consolidated Financial Statements - December 31, 2003

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

               Schedule II -- Valuation and Qualifying Accounts


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

     (3)  Listing of Exhibits

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

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

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


                                       57
<PAGE>


     3.1(d)    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.

     3.1(e)    Certificate of Designations, Preferences, Rights and Restrictions
               for Series B  Redeemable  Preferred  Stock dated March 30,  2004.
               Filed as an exhibit to Exhibit 10.20 to this Form 10-K.

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

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

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

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

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

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

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

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

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

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


                                       58
<PAGE>


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

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

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

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

     *+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    Warrant to Purchase Shares of Common Stock of  Scan-Optics,  Inc.
               dated  December  31,  2001,  is  filed  as  Exhibit  10.17 in the
               Company's  Annual  Report on Form 10-K  filed for the year  ended
               December 31, 2001.

     *+10.18   The  Scan-Optics,  Inc. Senior  Executive Stock Option Plan dated
               February 25, 2002 as filed as Exhibit  10.18 to Form S-8 filed on
               February 28, 2002.

     10.19     The  Scan-Optics,  Inc. 2002  Incentive and  Non-Qualified  Stock
               Option  Plan.

     10.20     Third Amended and Restated Credit Agreement dated as of March 30,
               2004 among Scan-Optics, Inc., the subsdiaries of Scan-Optics, the
               lenders parties thereto and Patriarch  Partners Agency  Services,
               LLC, as agent.

     *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.

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

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

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


                                       59
<PAGE>

     32.2      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.

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



     (b)  Reports on Form 8-K

          Report on Form 8-K was filed October 30, 2003 regarding  third quarter
          of 2003 earnings.

     (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.


                                       60
<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 30, 2004

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 30, 2004

/ss/
Peter H. Stelling
---------------------------             Chief Financial Officer, Vice President
                                        and Treasurer (Principal Financial and
                                        Accounting Officer)
                                        Date: March 30, 2004

/ss/
---------------------------
Logan Clarke, Jr.                       Director March 30, 2004

/ss/
---------------------------
Richard J. Coburn                       Director March 30, 2004

/ss/
---------------------------
E. Bulkeley Griswold                    Director March 30, 2004

/ss/
---------------------------
Lyman C. Hamilton, Jr.                  Director March 30, 2004

/ss/
---------------------------
John J. Holton                          Director March 30, 2004

/ss/
---------------------------
Robert H. Steele                        Director March 30, 2004

/ss/
---------------------------
Ralph J. Takala                         Director March 30, 2004

A majority of the Directors


                                       61


<PAGE>

<TABLE>
<CAPTION>
                                                            SCHEDULE II

                                                 SCAN-OPTICS, INC. AND SUBSIDIARIES
                                                  VALUATION AND QUALIFYING ACCOUNTS
                                         THREE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
                                                             (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, 2003
       Allowance for doubtful
       accounts (billed and unbilled)          $1,574            $22                                        $  462  (1)     $1,134

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

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

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


The required  information  regarding  the  valuation  allowance for deferred tax
assets is included in Note K.
</FN>
</TABLE>


                                                                 62