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

# FORM 10-KSB

| | (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
|---- |  | ----------------------------------------------------------------------------------------

Commission File Number:   000-08149

SCANNER TECHNOLOGIES CORPORATION(Name of small business issuer in its charter)

|New Mexico                      |  | 85-0169650                        | 
|------------------------------- |  | --------------------------------- | 
|(State or other jurisdiction of |  | (IRS Employer Identification No.) | 
|incorporation or organization)  | 

14505 21st Avenue North, Suite 220, Minneapolis, MN 55447
(Address of principal executive offices, Zip code)

(763) 476-8271
(Issuers telephone number)

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

| | Securities
registered pursuant to Section 12(g) of the Exchange Act:
| | --------------------------------------------------------------------

Common Stock, no par value
(Title of class)

Check whether the issuer
(1) filed all reports required to be filed by Section 13 or 15(d) of the
Exchange Act during the past 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

Check if there is no disclosure of
delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no
disclosure will 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-KSB
or any amendment to this Form 10-KSB.   [X]

The issuers revenues
for its most recent fiscal year were $2,833,338.

The aggregate market value
of the voting stock held by non-affiliates of the Company at March 12, 2004, was
$7,914,232, assuming that all executive officers, directors and 10% shareholders
known to the registrant are affiliates.

The Registrant had
10,426,724 shares of Common Stock, no par value, outstanding as of March 12,
2004.

# DOCUMENTS INCORPORATED BY REFERENCE

None.

Traditional Small Business Disclosure Format (Check one)  [  ]  Yes     [X]  No



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# SCANNER TECHNOLOGIES CORPORATION

# FORM 10-KSB

# Table of Contents

|                     |  | Page No.                                                      
|-------------------- |  | --------------------------------------------------------------
|PART I.              |  |                                                               
|Item 1.              |  | Description of Business.                                      
|Item 2.              |  | Description of Property.                                      
|Item 3.              |  | Legal Proceedings.                                            
|Item 4.              |  | Submission of Matters to a Vote of Security Holders.          
|PART II.             | 
|Item 5.              |  | Market for Common Equity and Related Stockholder Matters.     
|Item 6.              |  | Managements Discussion and Analysis or Plan of Operation.    
|Item 7.              |  | Financial Statements.                                         
|Item 8.              |  | Changes In and Disagreements With Accountants on Accounting   
|                     |  | and Financial Disclosure.                                     
|Item 8A.             |  | Controls and Procedures.                                      
|PART III.            | 
|Item 9.              |  | Directors, Executive Officers, Promoters and Control Persons: 
|                     |  | Compliance with Section 16(a) of the Exchange Act             
|Item 10.             |  | Executive Compensation.                                       
|Item 11.             |  | Security Ownership of Certain Beneficial Owners and Management
|                     |  | and Related Stockholder Matters.                              
|Item 12.             |  | Certain Relationships and Related Transactions.               
|Item 13.             |  | Exhibits and Reports on Form 8-K.                             
|Item 14.             |  | Principal Accountant Fees and Services.                       
|SIGNATURES           |  | 20                                                            
|FINANCIAL STATEMENTS |  | F-1                                                           
|EXHIBITS            

2

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# Introductory Statement

This Annual Report on Form 10-KSB
includes forward-looking statements within the meaning of the Securities Exchange Act of
1934, as amended, or the Exchange Act. These statements are based on our beliefs and
assumptions and on information currently available to us. Forward-looking statements
include, among others, the information concerning possible or assumed future results of
operations of Scanner Technologies Corporation and its subsidiary (Scanner) set forth
under the heading Managements Discussion and Analysis or Plan of
Operation. Forward-looking statements also include statements in which words such as
may, will, should, could,
expect, anticipate, intend, plan,
believe, estimate, predict, potential, or
similar expressions are used. Forward-looking statements are not guarantees of future
performance. Our future results and shareholder values may differ materially from those
expressed in these forward-looking statements. We caution you not to put undue reliance on
any forward-looking statements included in this document.

# PART I

# ITEM 1.   DESCRIPTION OF BUSINESS

# General Business Development

Scanner Technologies Corporation (the
company) was formerly known as Southwest Capital Corporation (Southwest
Capital) and was incorporated in 1964 under the laws of New Mexico. Originally
formed to provide financial services to small businesses, the Company divested itself of
such operations in 1990 and did not operate any business from 1992 until July 2002 when it
merged with Scanner Technologies Corporation, a privately held Minnesota corporation
(Scanner Minnesota). Scanner Minnesota had been formed in 1990 for the purpose
of inventing, developing and marketing vision inspection solutions for the semiconductor
industry. The Company is the legal entity surviving such merger; it changed its name to
Scanner Technologies Corporation at the merger and has continued to operate
the business acquired from Scanner Minnesota.

The Companys principal offices
are located at 14505 21st Ave. N., #220, in Minneapolis, Minnesota. Outside of the U.S.,
the Company has offices in Geneva, Switzerland and in Singapore, primarily engaged in
sales of Scanner products. To comply with local laws, the office in Singapore is operated
by Scanners wholly-owned subsidiary, Scanner Technologies Corporation International,
a Minnesota corporation.

# Industry

Scanner invents, develops and markets
vision inspection products that are used in the semiconductor industry for the inspection
of integrated circuits.

Integrated circuits can be divided
into two general categories:

| | Leaded
devices:   These are integrated circuits with fragile leads
extending from the perimeter of the package that provide the electrical
interconnects between the integrated circuit and the other components that
constitute an electronic product.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Ball array
devices:   These are integrated circuits that have an array
of small conductive spheres, or balls, mounted to the bottom of the integrated
circuit package. These balls serve the same function as the leads in the first
category.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Integrated circuits are designed to
be assembled to circuit substrates or printed circuit boards which are key components of
familiar products such as personal computers, cell phones, TVs, automotive
electronics, games, toys, DVD and CD players, satellites and avionics to name a few. Each
and every lead or ball must be accurately placed as defined by the integrated circuit
package specification to ensure

3

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a reliable interface between the
lead/ball and the circuit substrate. Any misalignment, due to bent leads, imperfectly
placed or damaged balls, or missing balls will result in a defective product.

The manufacture of integrated
circuits is a complex sequence of discrete steps that requires precise process controls
and verification through testing.

The last three steps prior to the
final Pack & Ship  1st Vision Inspection,
Electrical Test and 2nd Vision Inspection are the focus of
Scanners design efforts. During the final stages of the manufacturing process,
Singulation Trim & Form Ball Attach and Electrical Test, the
integrated circuits can be damaged requiring the 1st Vision Inspection and
2nd Vision Inspection.

# Scanner Products

Three-dimensional (3D) Inspection Modules

Many manufacturers of integrated circuit
devices use robotic inspection systems with a pick and place mechanism to automatically
inspect and sort integrated circuits in the manufacturing process. Such an inspection
system uses machine vision technology to inspect both leaded and ball array devices to
ensure that the devices conform to the specifications, then sorts them into pass or fail
categories. The inspection system can also perform other operations such as inspecting the
nomenclature printed on the package of the integrated circuit and sealing the good parts
into tape. The 3D inspection modules developed and manufactured by Scanner form the
machine-vision element of such inspection systems.

Customers purchasing Scanners
modules are generally included in the following two groups:

| | Original
Equipment Manufacturers (OEM) which integrate Scanners modules into
robotic inspection systems they produce for sale to end users; and
| | ------------------------------------------------------------------------------------------------------------------------------------------------

| | End users
themselves, i.e. the manufacturers and assemblers of integrated circuits.
| | -----------------------------------------------------------------------------------

Scanner has developed the following
core products as inspection modules:

| | UltraVim
Module, used for 3D inspections of leaded devices and 2D inspections of ball devices.
UltraVim Plus Module, used for 3D inspections of leaded devices as well as of ball
devices.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

4

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| | UltraMark,
used for the inspection of the nomenclature printed or etched on integrated circuits to
insure that the markings are correct and legible.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

The UltraVim Module and the UltraVim
Plus Module incorporate technology covered by patents owned by the Company.

The Company believes that
Scanners inspection modules have the following competitive advantages when compared
with similar products offered by Scanners competitors:

| |  |  | Scanners
modules do not have to be adjusted for various users, thereby reducing the operator skill
required to operate the inspection system and, therefore, lowering the associated labor
rate to the end user.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Scanners
modules are easy to set up and do not require extensive training, thereby reducing device
changeover costs and lowering operator training and support costs to the end user.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Scanners
modules make the high speed inspection of integrated circuits possible, thereby
increasing the manufacturing efficiency while reducing the total number of machines
required, which results in increased profits to the end user.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | The
automatic calibration of Scanners modules insures accurate inspections resulting in
increased yields and profits to the customer and lowers the operator skill required to
maintain the equipment and the associated labor rate to end user.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Three-dimensional (3D) Inspection Systems

In July 2002, Scanner
introduced the first in a series of products of three-dimensional inspection
systems under the product line name VisionFlex. Sales of these
inspection systems commenced during the year ended December 31, 2003.

# Markets for Scanners Products

According to the
Semiconductor Industry Association (SIA), global semiconductor sales rose to
$166.4 billion in 2003, up 18.3% from the global revenue of $140.8 billion
recorded in 2002. Semiconductor sales in 2004 are estimated to increase by at
least 19% up to 31%, mainly due to the demand for personal computers and cell
phones and increasing demands for consumer applications such as DVD players,
wireless internet and automotive applications. Semiconductor Equipment and
Materials International (SEMI), a trade association of semiconductor
equipment and material manufacturers, estimates that sales of semiconductor
equipment totaled $21.4 billion in 2003. SEMI expects the market for
semiconductor equipment to increase by 39% in 2004 and 18% in 2005, but to
decrease in 2006 by 6.6% because new capacity is anticipated to go into
production at that time. These predictions regarding both semiconductor sales
and sales of semiconductor equipment may prove to be incorrect, however, and
Scanner can provide no assurance as to when or if the worldwide semiconductor
equipment market will continue to grow.

As shown in the flow chart
above, the first vision inspection in a standard assembly process is followed by
the electrical test that is in turn followed by a second vision inspection.
During the electrical test, the leads/balls of the integrated circuit must make
physical contact with the tester that carries the risk of damaging the
integrated circuit itself. This risk makes the second vision inspection
necessary to ensure that the integrated circuit complies with the device
specifications before shipment. A substantial portion of Scanners sales
are derived from the integration of the UltraVim or the UltraVim Plus Module
into existing test handlers, thereby eliminating the need for the stand-alone
second vision inspection.

5

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# Sales and Marketing

Scanner sells its products through
direct sales offices in San Jose, California, Singapore and Geneva, Switzerland and, in
key geographical markets, through sales representatives throughout the world. For Japan,
Scanner has a distributor agreement with Yamatake Honeywell.

# Manufacturing

Scanner designs its own products and
out-sources the manufacturing of parts. The Companys research and development,
engineering and designing operations, as well as the system assembly, are located at the
facility in Tempe, Arizona. The vision inspection modules that are sold to our OEM
customers or built into the systems we are currently manufacturing ourselves are assembled
at the Companys facility in Minneapolis, Minnesota.

# Competition

The market for the inspection of
integrated circuits is highly competitive. Numerous companies, several of them public
companies with greater financial resources and a longer operating history, compete with
Scanner for market share. Competitors are, among other companies, Camtek Ltd.,
Hitachi, Ltd., ICOS Vision Systems Corp. N.V., Robotic Vision Systems, Inc. and
Toray Industries, Inc.

# Proprietary Rights

The Company holds nine U.S. patents
for Scanners innovative technologies and additional patents are pending in the
United States and strategic countries worldwide. Prior to the merger with Southwest
Capital in July 2002, all patents were owned by Elwin M. Beaty and Elaine E. Beaty. Upon
completion of the merger with Southwest Capital, Scanner acquired all patents in exchange
for (i) a one-time payment to Mr. and Mrs. Beaty of $1, (ii) the reimbursement of all
expenses for filing fees, legal fees and other disbursements which Mr. and Mrs. Beaty have
incurred since 1991 for securing and maintaining the intellectual property rights, which
expenses equaled $370,504, and (iii) the payment of all unpaid and accrued license fees
payable to Mr. and Mrs. Beaty as of July 31, 2002, which amounted to $89,354. As of
December 31, 2003, Scanner has paid all amounts owed Mr. and Mrs. Beaty for these
obligations. The patents essential for our product development and manufacturing will
expire from May 2017 through January 2018.

# Dependence on Few Major
Customers

Approximately 66% of the
Companys revenues in 2003 were from three customers. They included Manufacturing
Integration Technology Ltd (33%), Horng Terng Automotive Co., Ltd. (20%) and Yamatake
& Co., Ltd. (13%).

# Employees

As of December 31, 2003, Scanner
employed five people at its manufacturing facility in Tempe, Arizona, six people at its
facility in Minneapolis, Minnesota, and five people in its other offices in San Jose,
California, Singapore and Geneva, Switzerland. Three of these employees work in
manufacturing, three work in sales and marketing, two provide professional services such
as training and general product assistance, four work in product development and four
provide general administrative services. All of Scanners employees are working
full-time. Scanners relationships with its employees are good.

# ITEM 2.   DESCRIPTION OF PROPERTY

The Company leases manufacturing and
administrative facilities in Minneapolis, Minnesota and Tempe, Arizona and also maintains
sales offices in San Jose, California, Singapore and Geneva, Switzerland. The

6

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leases require monthly base rents
plus increases for operating expenses and/or property taxes. Approximate future minimum
lease payments are $123,300, $103,900, $102,000 and $20,100 in 2004 through 2007,
respectively. The Company believes that its existing facilities are adequate to meet its
current needs and that suitable additional or alternative space will be available in the
future on commercially reasonable terms.

# ITEM 3.   LEGAL PROCEEDINGS

In 2000, the Company instituted a
lawsuit against ICOS Vision Systems Corp. N.V., a Belgian corporation, for infringement of
two of its patents. The patents relate to three-dimensional ball array inspection
apparatus and method. Discovery was completed in the case and a so-called Markman hearing
was held in November 2001. In June 2003, the Company and the Belgian corporation reached a
settlement concerning one illumination source inspection systems. Pursuant to the
settlement agreement, the Belgian corporation made a one-time payment of $400,000 to the
Company to settle all issues with regard to these one light source inspection systems. The
court found no infringement with regard to the two illumination source devices that the
Belgian corporation sold. The Company agreed to the settlement agreement with respect to
one light source devices in order to allow it to immediately appeal the courts
ruling concerning inspection systems involving two light sources, eliminating the need,
delay and expense of a trial with regard to these systems at this stage. The Company
intends to continue to vigorously enforce its patent rights and expects to incur
significant additional expenses in 2004 to pursue their appeal. The Company believes that
any unfavorable decision will not have a material adverse effect on the consolidated
financial statements. In connection with the settlement, the Company paid its President
$160,000 pursuant to a prior agreement (See Executive Compensation). The
$400,000 settlement less the $160,000 paid to the President is recorded at net in other
income in the consolidated financial statements.

In 2002, the Company brought suit
against two law firms that previously represented the Company in the patent litigation
described above. The Company demanded a full and complete accounting for the fees and
expenses charged by these firms in connection with the patent litigation. The Company has
paid the law firms the total amount of $558,652 in legal fees and costs. The law firms
claimed that the Company owed them an additional $402,984. The trial took place in
December 2003. In January 2004, the court decided that the number of hours billed by the
law firms was grossly excessive and, therefore, reduced the amount still payable to the
law firms by approximately $320,000. At December 31, 2003 and 2002, the entire amount
requested by the law firms of $402,984 was included in accounts payable in the
consolidated balance sheets. Scanner will reflect the reduction in accounts payable and
record other income in its consolidated financial statements for the quarter ending March 31, 2004.

# ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote
of security holders during the fourth quarter of 2003.

# PART II

# ITEM 5.   MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

# Dividends

The Company has never paid cash
dividends on its Common Stock and does not intend to do so in the foreseeable future. The
Company currently intends to retain its earnings for the operation and expansion of its
business. The Companys continued need to retain earnings for operations and
expansion is likely to limit the Companys ability to pay future cash dividends.

7

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# Market Information

The Companys Common Stock is
currently quoted on the National Association of Securities Dealers, Inc. Over-the-Counter
Bulletin Board (OTCBB) under the symbol SCNI.OB. The following
table sets forth, for the period from January 1, 2002 through December 31, 2003, the range
of high and low bid information for the Companys Common Stock on the OTCBB. The
prices represent quotations between dealers without adjustment for retail markups,
markdowns, or commissions and may not represent actual transactions

|               | 2003 |  | 2002
|-------------- | ---- |  | ----
|
|First Quarter  |      |  | $   
|Second Quarter |      |  |     
|Third Quarter  |      |  |     
|Fourth Quarter |      |  |     

The shares of Common Stock are
subject to various governmental or regulatory body rules, including the Securities Act of
1933 and regulations thereto, the Securities Act of 1934 and regulations thereto, and
rules promulgated by NASD, which may affect the liquidity of the shares.

# Holders

There were approximately 900 holders
of record of the Companys Common Stock as of December 31, 2003.

# Issuance of Common
Stock, Warrants and Stock Options

In the three months ended December 31, 2003, the Company issued five-year warrants to purchase 250,000 shares of common stock
at $1.35 per share in exchange for professional services related to financing
arrangements.

# ITEM 6.   MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

# General

The Company generates revenues from
the sale of machine-vision inspection devices used in the semiconductor industry for the
inspection of integrated circuits. The devices include machine-vision modules sold to
original equipment manufacturers that use the modules as a component of inspection systems
they sell to end users, as well as complete machine-vision inspection systems that the
Company sells to end users. Because the Company sells relatively few of its devices each
year, the Companys business is characterized by uneven quarterly results that are
dependent on the timing of sales and revenue recognition.

During recent years, the
Companys operations were adversely affected by a lack of demand in the semiconductor
marketplace, which caused many of the Companys potential customers to cease or defer
purchases of capital equipment such as the inspection equipment offered by the Company.
SEMI, a trade association of semiconductor equipment and material manufacturers, estimates
that sales of semiconductor equipment rose from $19.7 billion in 2002 to $21.4 billion in
2003. SEMI expects the market for semiconductor equipment to increase by 39% in 2004 and
18% in 2005, but to decrease in 2006 by 6.6% because new capacity is anticipated to go
into production at that time. The Company believes the general improvement in industry
conditions contributed to the improvement in the Companys operations in 2003. The
Company will continue to be subject to the cyclical nature of the semiconductor
marketplace.

8

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In addition to general trends in the
semiconductor marketplace, the Company must compete for sales with other providers of
machine-vision inspection equipment, most of whom are larger, better financed and offer a
broader selection of products. The Company must compete on the basis of price, product
performance including speed and size of defects detected, ease of use and technological
advancement. During 2003, the Company commenced sales of its VisionFlex inspection
systems, which were introduced in July 2002. The Company must continue research and
development to improve existing products and introduce new products in order to compete
effectively with other providers of inspection equipment.

The Companys working capital
position improved in 2003 primarily due to the sale of common stock. The Company continues
to operate with limited working capital resources and must increase revenues sufficient to
generate cash flow from operations or seek additional financing, or both, in order to
sustain operations. In order to obtain additional debt or equity financing, the Company
may be obligated to issue additional shares of Common Stock or warrants or other rights to
acquire Common Stock on terms that will result in dilution to existing shareholders or
place restrictions on operations. The Company may also be unsuccessful in increasing
revenues or obtaining additional equity capital or bank financing on any terms and in that
event may be obligated to cease operations and/or attempt to negotiate with its creditors
to delay payments or compromise the amounts of its indebtedness.

# Critical Accounting Policies

The discussion and analysis of
financial condition and results of operations is based upon the consolidated financial
statements, which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and liabilities. The
Company evaluates, on an on-going basis, its estimates and judgments, including those
related to bad debts, excess inventory, warranty obligations, income taxes, contingencies
and litigation. Its estimates are based on historical experience and assumptions that we
believe to be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates under
different assumptions or conditions.

The Company believes the following
critical accounting policies, among others, affect its more significant judgments and
estimates used in the preparation of its consolidated financial statements.

- Revenue recognition;
- Allowances for doubtful accounts and excess and obsolete inventory;
- Patent rights;
- Accounting for income taxes;
- Accounting and valuation of options and warrants.

Revenue is earned primarily through
sales of test equipment to third party customers and also to a distributor. For sales to
the distributor, revenue is recognized upon shipment as the distributor has no acceptance
provisions and title passes at shipment. For sales to third party customers, title passes
at shipment, however the customer has certain acceptance provisions relating to
installation and training. These provisions require the Company to defer revenue
recognition until the equipment is installed and the customers personnel are
trained. The Company provides the training but does not install the equipment. As a
result, revenue is recognized for third party customers once the product has been shipped,
installed and customer personnel are trained. This process typically is completed within
two weeks to a month after shipment.

Accounts receivable arise from the
normal course of selling products on credit to customers. An allowance for doubtful
accounts has been provided for estimated uncollectable accounts. Accounts

9

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receivable, historical bad debts,
customer concentrations, customer creditworthiness, current economic trends and changes
in customer payment terms and practices are analyzed when evaluating the adequacy of the
allowance for doubtful accounts. Individual accounts are charged against the allowance
when collection efforts have been exhausted.

Inventory is stated at the lower of
cost or market with cost determined on the first-in, first-out method. The Company has
provided an allowance for estimated excess and obsolete inventory equal to the difference
between the cost of inventory and the estimated fair value based on assumptions about
future demand and market conditions.

Patent rights are stated at cost less
accumulated amortization. Amortization is provided using the straight-line method over six
years. Patent rights are reviewed for impairment when events or changes in circumstances
indicate that the carrying value of the asset may not be recoverable. An impairment loss
is recognized when estimated discounted cash flows to be generated by those assets are
less than the carrying value of the asset. When impairment loss is recognized, the
carrying amount is reduced to its estimated fair value, based on appraisals or other
reasonable methods to estimate value.

The Company accounts for income taxes
using the asset and liability approach in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. The asset
and liability approach requires the recognition of deferred tax liabilities and assets for
the expected future tax consequences of temporary differences between the carrying amounts
and the tax basis of assets and liabilities. The effect on deferred taxes of a change in
tax rates is recognized in operations in the period that includes the enactment date.
Additionally, deferred tax assets are evaluated and a valuation allowance is established
if it is more likely than not that all or a portion of the tax asset will not be utilized.

The Company accounts for employee
stock options under Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and provides the disclosures required by SFAS No. 123,
Accounting for Stock-Based Compensation. Options and warrants to non-employees
are accounted for as required by SFAS No. 123.

The Company estimates the fair value
of warrants at the grant date using the Black-Scholes option pricing model. The model
takes into consideration weighted average assumptions related to the following: risk-free
interest rate; expected life years; expected volatility; and expected dividend rate. Since
the Companys stock is thinly traded, the Company is essentially a nonpublic entity.
Therefore, volatility is set at 0% as permitted by SFAS No. 123. The costs associated with
the warrants issued in connection with the line of credit are recorded as deferred
financing costs. These costs are being amortized over the term of the line of credit, and
the net unamortized balance is offset against stockholders equity.

# Liquidity and Capital Resources

During 2003, the Company sold 100,000
shares of common stock at $2.50 per share, for an aggregate amount of $250,000 under a
private placement offering. Warrants to purchase an additional 25,000 shares of common
stock at $3.00 per share were issued in connection with these sales. The warrants expire
three years after issuance and had no market value as determined by the Black-Scholes
option pricing model.

In 2003, the Company renewed its bank
line of credit through May 1, 2004. The line was increased from $900,000 to $1,300,000
with an interest rate at prime (4.00% and 4.25% at December 31, 2003 and 2002,
respectively) and the Company provided the bank with a security interest in its general
business assets. The Companys outstanding indebtedness under the line of credit at
December 31, 2003 was $701,000. The line is guaranteed by individuals who received for
their financial support: (a) five-year warrants to purchase 325,000 shares of the
Companys common stock at $2.75 per share and (b) thirty-day warrants to purchase an
additional 325,000 shares of the Companys common stock at $2.00 per share. Provided

10

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the guarantor paid cash for at least
one half of the shares subject to their thirty-day warrant, such guarantor was permitted
to purchase the remainder of the shares with a promissory note, collateralized by the
shares purchased, payable one year from date of exercise. The guarantors exercised all
such warrants in exchange for aggregate cash payments to the Company of $350,000 and one
year promissory notes issued to the Company with an aggregate principal amount of
$300,000. One of the promissory notes in the amount of $25,000 was paid in August 2003.
The remaining principal amounts are due in April and May 2004. In connection with the
exercise of their thirty-day warrants, the guarantors were granted two-year warrants to
purchase an additional 650,000 shares of the Companys common stock at $2.00 per
share. All of the warrants issued to the guarantors had a market value of $574,671, as
determined by the Black-Scholes option pricing model.

The Company believes that this line
of credit, existing working capital and anticipated cash flows from operations and equity
investments will be adequate to satisfy projected operating and capital requirements for
the next year.

At December 31, 2003, the
Companys obligations and commitments to make future payments under debt and lease
agreements are as follows:

|                 | Payments due by Year
|---------------- | --------------------
|
|Line of credit   |                     
|Notes payable    |                     
|Operating leases |                     
|
|                 |                     
|

Net cash used by operating activities
totaled $426,392 and $920,433 in 2003 and 2002, respectively. Negative operating cashflows
resulted primarily from net operating losses which were partially offset by non-cash
adjustments of $499,959 and $499,787 in 2003 and 2002, respectively, relating primarily to
depreciation and amortization, deferred taxes and deferred stock option compensation and
by net decreases (increases) in operating assets and liabilities of ($461,784) and
$599,929 in 2003 and 2002, respectively.

Net cash used by investing activities
totaled $14,616 and $15,280 in 2003 and 2002, respectively. The funds were used to
purchase property and equipment.

Net cash provided by financing
activities totaled $580,053 and $600,000 in 2003 and 2002, respectively. Positive
financing cashflows related primarily to the proceeds from the sale of common stock and
exercise of warrants and stock options, $625,477 and $133,070 in 2003 and 2002,
respectively and new borrowings and increased borrowings under the line of credit offset
by (payments) on related party debt, ($45,424) and $466,930 in 2003 and 2002,
respectively.

The Company issued $100,000 of notes
payable in the year ended December 31, 2003.

# Results of Operations

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Sales for the year ended December 31,
2003, were $2,833,338 compared to $1,241,215 for the year ended December 31, 2002. The
Companys revenues continue to be adversely affected by the lack of demand in the
semiconductor industry which has caused reduced spending by semiconductor manufactures for
capital equipment such as that offered by the Company. The sales increase in 2003 relates
primarily to the initial sales of the Companys robotic inspection systems to end
users and an increase in the purchases of capital equipment by customers in the
semiconductor industry.

11

---

Cost of goods sold increased by
$466,272 to $827,685 in the year ended December 31, 2003, from $361,413 in 2002. Cost of
goods sold as a percentage of sales increased by 0.1% to 29.2% in 2003 compared to 29.1%
in 2002. In 2003, manufacturing expenses decreased as a percent of sales primarily because
of the increase in sales. This decrease was offset by an increase in material cost as a
percent of sales.

Selling, general and administrative
expenses decreased by $269,150 to $1,333,832 for the year ended December 31, 2003,
compared to $1,602,982 in the prior year. Decreases in professional costs, amortization of
deferred stock option compensation and license fees were partially offset by increases in
salaries and related expenses and amortization of patent rights.

Research and development expenses
were $530,362 in the year ended December 31, 2003 compared to $798,650 for the year ended
December 31, 2002. The research and development activities related to the Companys
development of its own line of robotic inspection systems for sale to end users which
activities were in their early stages in 2002. The development process continued in 2003
with the first unit being sold in April 2003.

Legal fees decreased by $157,096 to
$390,515 in the year ended December 31, 2003, from $547,611 in 2002. A significant portion
of the legal fees in both periods related to the patent infringement claim brought by the
Company against a competitor.

Other income (expense) was ($212,711)
in the year ended December 31, 2003, compared to ($22,608) in 2002. In 2003, the Company
settled a portion of its litigation relating to its patent infringement claim for
$400,000. In connection with the settlement and a prior agreement, the Company paid its
President $160,000. The net amount of $240,000 is included in other income in 2003.
Interest expense was $429,948 higher in 2003 than it was in 2002. The increase relates
primarily to the $397,849 amortization of the warrant valuation related to the renewal of
the line of credit and to additional debt outstanding.

The Company recognized no income tax
benefit to offset the loss before income taxes in the year ended December 31, 2003, as no
tax benefit is available to the Company. The $2,800 of taxes provided in the year ended
December 31, 2003 represented minimum state taxes. A benefit of $71,900 was recognized in
the year ended December 31, 2002.

The net loss for the year ended
December 31, 2003 was $464,567, or $.05 per share, compared to a net loss of $2,020,149,
or $.24 per share, in 2002. The decrease in the net loss was the result of an increase in
gross margin of $1,125,851 and decreased operating expenses of $694,534, offset by
increased net nonoperating expenses of $190,103 and by increased income taxes of $74,700.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Sales for the year ended December 31,
2002, were $1,241,215 compared to $1,772,625 for the year ended December 31, 2001. The
decline in sales is principally due to the worldwide slow demand for semiconductor and
microelectronic devices. Therefore, manufacturers of such devices are reducing their
capital spending which negatively affects semiconductor equipment suppliers such as the
Company.

Cost of goods sold decreased by
$96,318 to $361,413 in the year ended December 31, 2002, from $457,731 in 2001. The
decrease was primarily related to the decrease in sales. Cost of goods sold as a
percentage of sales increased by 3.3% to 29.1% in 2002 compared to 25.8% in 2001. This
increase was the result of higher fixed and variable manufacturing expenses.

Selling, general and administrative
expenses decreased by $71,097 to $1,602,982 for the year ended December 31, 2002, compared
to $1,674,079 in the prior year. The decrease was primarily related to lower commission
and other selling expenses because of the decreased sales. These decreases were partially
offset by increased accounting and other professional costs.

12

---

Research and development expenses
were $798,650 in the year ended December 31, 2002 compared to $631,514 for the year ended
December 31, 2001. The research and development activities related to the early stages of
the Companys development of its own line of robotic inspection systems for sale to
end users.

Legal fees decreased by $170,463 to
$547,611 in the year ended December 31, 2002, from $718,074 in 2001. Legal fees related to
the patent infringement claim brought by the Company against a competitor were less in
2002 than 2001.

Other income (expense) was ($22,608)
in the year ended December 31, 2002, compared to $9,803 in 2001. The change is primarily
due to reduced cash investments and increased debt.

The Company recognized an income tax
benefit of $71,900 in the year ended December 31, 2002. The benefit was limited because
all of the available carrybacks were utilized. A benefit of $395,746 was recognized in the
year ended December 31, 2001.

The net loss for the year ended
December 31, 2002 was $2,020,149, or $.24 per share, compared to a net loss of $1,303,224,
or $.19 per share, in 2001. The increase in the net loss was the result of a decrease in
gross profit of $435,092, increased net nonoperating expenses of $32,411, a decrease in
income tax benefit of $323,846 offset by a decrease in operating expenses of $74,424.

# ITEM 7.   FINANCIAL STATEMENTS

The Companys financial
statements, and the report of Lurie Besikof Lapidus & Company, LLP, independent
auditors, referred to in the Index to Financial Statements, appear elsewhere in this Form
10-KSB on the pages set forth.

INDEX

|                                                | Page
|----------------------------------------------- | ----
|INDEPENDENT AUDITORS REPORT                    |     
|CONSOLIDATED FINANCIAL STATEMENTS               |     
|Consolidated balance sheets                     |     
|Consolidated statements of operations           |     
|Consolidated statements of stockholders equity |     
|Consolidated statements of cash flows           |     
|Notes to consolidated financial statements      |     

# ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

# ITEM 8A.   CONTROLS AND PROCEDURES

As of the end of the period covered
by this report, the Company conducted an evaluation under the supervision and with the
participation of the companys management, including the Companys Chief
Executive Officer and Chief Financial Officer, regarding the effectiveness of the design
and operation of

13

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the Companys disclosure
controls and procedures pursuant to Rules 13a-15(b) of the Securities Exchange Act of
1934 (the Exchange Act). Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Companys disclosure controls
and procedures are effective to ensure that information that is 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 period specified in the rules of the Securities
Exchange Commission. There were no changes in the Companys internal control over
financial reporting that occurred during the period covered by this report that have
materially affected, or are reasonably likely to materially affect, the Companys
internal control over financial reporting.

# PART III

# ITEM 9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

# Directors and Officers

The Companys directors are
elected at the annual meeting of stockholders and hold office for an indefinite term that
expires at the next regular meeting of shareholders or until their successors are elected
and qualified. The Companys officers are appointed by the Board of Directors and
approved and ratified by the Board.

The names, ages, and respective
positions of the officers and directors of the Company are set forth below, as well as
additional information relating to each officer and director.

|Name           |  | Age |  | Position                                                                
|-------------- |  | --- |  | ------------------------------------------------------------------------
|Elwin M. Beaty |  | 62  |  | President, Chief Executive Officer, Chief Financial Officer and Director
|David P. Mork  |  | 36  |  | Senior Vice President and Director                                      

Elwin M. Beaty has served as
the President, Chief Executive Officer and Chief Financial Officer and a Director of the
Company since the merger of the Company and Scanner Technologies Corporation, a
privately-held Minnesota corporation (Scanner Minnesota), on July 31, 2002
(the Merger). Prior to the Merger, Mr. Beaty served in the same capacities
with Scanner Minnesota since its incorporation in November 1990.

David P. Mork has served as
the Senior Vice President of the Company since the Merger. Mr. Mork served as Senior Vice
President of Scanner Minnesota from 1997 until the Merger. He has also served as a
Director of the Company since the Merger.

# Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities
Exchange Act of 1934 requires the Companys officers and directors, and persons who
own more than 10% of a registered class of the Companys equity securities, to file
reports of ownership and changes in ownership with the Securities and Exchange Commission
(SEC). Officers, directors and greater than 10% shareholders are required by
SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, the Company
believes that, during 2003, all officers, directors, and greater than 10% shareholders
complied with the applicable filing requirements.

# Audit Committee Expert

The Board of Directors serves as the
Audit Committee, and there are no independent directors on the Board. The Board has
designated Elwin M. Beaty, President, Chief Executive Officer and Chief Financial Officer
of the Company, as its financial expert as defined by Item 401(e) of Regulation S-B under
the Securities Act of 1933.

14

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# Procedures for Recommendation of Director Nominees

The Company does not have a formal
procedure in place by which a shareholder may recommend a nominee to the Companys
Board of Directors.

# Code of Ethics and Business Conduct

The Company is working with its legal
counsel to prepare and adopt a Code of Ethics and Business Conduct.

# ITEM 10.   EXECUTIVE COMPENSATION

# Employment Agreements and Arrangements

Pursuant to an employment agreement
between the Company and Elwin M. Beaty, President, Chief Executive Officer and Chief
Financial Officer of the Company, Mr. Beaty earns an annual salary of $180,000. The
agreement also contains a provision that requires the Company to pay Mr. Beaty an amount
equal to the annual salary if he is terminated without cause. The agreement can be
terminated by either the Company or Mr. Beaty with a 30-day written notice to the other.

In an agreement dated April 19, 2002,
Mr. Beaty forgave the Companys obligation to pay him accrued salary of $1,254,575
and released the Company, its successors, its officers and directors from any liability in
connection with the accrued salary. In exchange, the Company agreed that Mr. Beaty shall
receive a certain amount of the proceeds, if any, that Scanner may receive out of
litigation involving patents that Scanner has licensed. Under the agreement, the Company
shall keep sixty percent (60%) of any proceeds of the currently ongoing litigation and
shall pay to Mr. Beaty forty percent (40%) of such proceeds until the Company has been
reimbursed for all attorney fees and other expenses incurred in connection with the
current litigation, and Mr. Beaty has received the total amount of $1,254,575. If one
party has received all the amounts owing to such party before the other partys claim
under this provision has been satisfied, the other party shall receive one hundred percent
(100%) of the proceeds until its claim is satisfied. If any proceeds remain after such
payment, Mr. Beaty shall receive fifty percent (50%) of such remainder. He also has a
right to receive part of the proceeds, if any, that the Company may receive out of any
subsequent litigation involving the licensed patents. The Company shall keep sixty percent
(60%) of any proceeds from subsequent litigation until its attorney fees and other
expenses incurred in connection with the current and any subsequent litigation have been
reimbursed, and Mr. Beaty shall receive forty percent (40%) of any proceeds from
subsequent litigation until he has received a total amount of $1,254,575 out of the
proceeds of the currently ongoing and any subsequent litigation. If any proceeds out of
the subsequent litigation remain after such distribution, the Company shall pay twenty
five percent (25%) of such remaining proceeds to Mr. Beaty. The unearned compensation
forgiven ($1,254,575) less the related deferred tax benefit ($436,000) was recorded as
additional paid-in capital in stockholders equity.

In 2003, the Company received a
one-time payment of $400,000 from a Belgian corporation pursuant to a settlement agreement
related to all patent infringement issues with regard to one light source inspection
systems. In connection with the settlement, the Company paid $160,000 to Mr. Beaty
pursuant to the agreement noted above.

15

---

To provide David P. Mork, the
Companys Senior Vice President, with an incentive to continue his employment with
the Company, and to compensate him for compensation in recent years which the Company
believes was less than he might have received in a comparable position elsewhere, Mr. Mork
was also a party to the agreement described above regarding the distribution of litigation
proceeds. Pursuant to the agreement, the Company has agreed to pay to Mr. Mork twenty
percent (20%) of the remaining proceeds, if any, that the Company may receive out of the
currently ongoing litigation, and twenty-five percent (25%) of the remaining proceeds, if
any, that the Company may receive out of any future litigation involving the licensed
patent, and that remain after the aforesaid payments to the Company and to Mr. Beaty have
been made out of such proceeds.

# Summary Compensation
Table

The following Summary Compensation
Table sets forth certain compensation information for services rendered in all capacities
to us by our chief executive officer and by the only other executive officer whose total
salary and bonus exceeded $100,000 during 2003.

|                           | FiscalYear |      | Annual Compensation |         | Long TermCompensation
|-------------------------- | ---------- | ---- | ------------------- | ------- | ---------------------
|
|                           |            |      |                     |         |                      
|Elwin M. Beaty             |            | 2003 |                     | 180,000 |                      
|President, Chief           |            | 2002 |                     | 180,000 |                      
|Executive Officer and      |            | 2001 |                     | 180,000 |                      
|Chief Financial Officer(1) |           
|David P. Mork              |            | 2003 |                     | 120,000 |                      
|Senior Vice President(1)   |            | 2002 |                     | 114,750 |                      
|                           |            | 2001 |                     | 114,500 |                      

(2)    Includes
$160,000 from proceeds of a patent litigation settlement paid to Mr. Beaty and
$3,772 for rent expense for Mr. Beatys temporary residence in Arizona.

# Option Grants During 2003 Fiscal Year

The Company did not grant any stock
options during year ended December 31, 2003 to the named executive officers in the Summary
Compensation Table. The Company has not granted any stock appreciation rights. The Company
does not have a stock option plan.

# Option Exercises During 2003 Fiscal Year and Fiscal Year-End Option Values

No options were exercised
during fiscal 2003 or held as of December 31, 2003 by the named executive
officers in the Summary Compensation Table. The Company has no outstanding stock
appreciation rights.

# Compensation to Directors

The Companys directors do not
receive any compensation from the Company for their services as a director.

16

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# ITEM 11.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The Company had no
outstanding equity compensation plans as of December 31, 2003.

The following table sets
forth, as of March 12, 2004, certain information with respect to beneficial
ownership of our Common Stock by (i) each of our executive officers named
in the summary compensation table above, (ii) each of our directors,
(iii) each person known to us to be the beneficial owner of more than 5% of
our outstanding Common Stock, and (iv) all of the directors and executive
officers as a group.

|Name and Address(1)                       | Shares OwnedBeneficially &of Record(2) |           | PercentageStockOutstanding(2)
|----------------------------------------- | -------------------------------------- | --------- | -----------------------------
|                                          |                                        |           |                              
|Elwin M. Beaty                            |                                        | 6,708,732 | (3)                          
|David P. Mork                             |                                        | 501,660   | (4)                          
|Elaine E. Beaty                           |                                        | 6,708,732 | (5)                          
|All Executive Officers and Directors as a |                                        | 7,210,392 |                              
|group (2 persons)                         |                                       

(1)    
The address for each individual is 14505 21st Avenue North, Suite 220,
Minneapolis, MN 55447.

(2)    
For purposes of computing beneficial ownership and the percentage of
outstanding Common Stock held by each person or group of persons named above as
of March 12, 2004, any security which such person or group of persons has the
right to acquire within 60 days after such date is deemed to be outstanding for
the purpose of computing beneficial ownership and the percentage ownership of
such person or persons, but is not deemed to be outstanding for the purpose of
computing the percentage ownership of any other person.

(3)    
Includes (a) warrants to purchase 670,782 shares of Common Stock at $1.00 per
share exercisable immediately, (b) 2,683,584 shares of Scanner Common Stock
owned by Elaine E. Beaty, Mr. Beatys spouse, and (c) warrants to purchase
670,782 shares of Scanner Common Stock exercisable immediately owned by Elaine
E. Beaty, Mr. Beatys spouse. Mr. Beaty disclaims the beneficial ownership
of the securities owned by his wife.

(4)    
Includes warrants to purchase 70,310 shares of Common Stock at $1.00 per share
exercisable immediately.

(5)    
Includes (a) warrants to purchase 670,782 shares of Common Stock at $1.00 per
share exercisable immediately, (b) 2,683,584 shares of Scanner Common Stock
owned by Elwin M Beaty, Mrs. Beatys spouse, and (c) warrants to purchase
670,782 shares of Scanner Common Stock exercisable immediately owned by Elwin M.
Beaty, Mrs. Beatys spouse. Mrs. Beaty disclaims the beneficial ownership
of the securities owned by her husband.

# ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

See Executive
Compensation for a description of transactions between the Company and the
Companys officers.

17

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# ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K

# Exhibits:

See Exhibit Index following the financial pages of this report.

# Reports on Form 8-K:

None.

# ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

# Audit Fees

The aggregate fees billed for the
year ended December 31, 2003 for professional services rendered by the principal
accountant for the audit of our annual financial statements and review of the financial
statements included in our Form 10-QSB or services that are normally provided by the
accountant in connection with statutory and regulatory filings or engagements for the year
ended December 31, 2003 were estimated as $31,600 that we paid to our current accountant,
Lurie Besikof Lapidus & Company, LLP.

The aggregate fees billed for the
year ended December 31, 2002 for professional services rendered by the principal
accountant for the audit of our annual financial statements were estimated as $12,700 that
we paid to our prior accountant, Lethert, Skwira, Schultz & Co. LLP.

# Audit Related Fees

None.

# Tax Fees

The aggregate fees billed for the
year ended December 31, 2003 for professional services rendered by the principal
accountant for the tax return preparation and tax advice relating to IRS examinations were
estimated as $11,950 and $2,475, respectively, that we paid to our current accountant,
Lurie Besikof Lapidus & Company, LLP.

The aggregate fees billed for the
year ended December 31, 2002 for professional services rendered by the principal
accountant for the tax return preparation and tax advice relating to IRS examinations were
estimated as $5,000 and $2,500, respectively, that we paid to our prior accountant,
Lethert, Skwira, Schultz & Co. LLP.

# All Other Fees

The aggregate fees billed for the
year ended December 31, 2003 for professional services rendered by the principal
accountant for the SEC filings and accounting consultations were estimated as $2,200 and
$855, respectively, that we paid to our current accountant, Lurie Besikof Lapidus &
Company, LLP.

The aggregate fees billed for the
year ended December 31, 2002 for professional services rendered by the principal
accountants for other services were estimated as follows: (a) we paid our prior
accountant, Lethert, Skwira, Schultz & Co. LLP, $45,000 for services related to SEC
filings and additional accounting services related to the merger of the Company with
Scanner Minnesota and $12,595 for accounting consultations and monthly financial
assistance; and (b) we paid our current accountant, Lurie Besikof Lapidus & Company,
LLP, $60,000 related to SEC filings and additional accounting services related to the
merger of the Company with Southwest Capital Corporation, $5,000 related to the review of

18

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financial statements included in the
filing on Form 10-QSB and $8,200 related to general accounting, tax and financial
reporting consultations.

# Audit Committee Policy
and Procedures

The Company does not have an audit
committee.

# Work Performed by
Persons Other Than Principal Accountant

Not applicable.

19

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# SIGNATURES

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

|                       |                                                                     |                                  |  |                     | 
|---------------------- | ------------------------------------------------------------------- | -------------------------------- |  | ------------------- | 
|                       |                                                                     | SCANNER TECHNOLOGIES CORPORATION
|DATE:   March 29, 2004 |                                                                     | By:                              |  | /s/   Elwin M Beaty | 
|                       |                                                                    
|                       | Elwin M. BeatyChief Executive Officer   and Chief Financial Officer |                                 

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

|                       |                                                                                                                                                             |                                  |  |                     | 
|---------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------- |  | ------------------- | 
|                       |                                                                                                                                                             | SCANNER TECHNOLOGIES CORPORATION
|DATE:   March 29, 2004 |                                                                                                                                                             | By:                              |  | /s/   Elwin M Beaty | 
|                       |                                                                                                                                                            
|                       | Elwin M. BeatyChief Executive Officer,   Chief Financial Officer and Director(Principal executive officer and principal   financial and accounting officer) |                                 
|DATE:   March 29, 2004 |                                                                                                                                                             | By:                              |  | /s/   David P. Mork | 
|                       |                                                                                                                                                            
|                       | David P. MorkSenior Vice President and Director                                                                                                             |                                 

20

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# EXHIBIT INDEX

# SCANNER TECHNOLOGIES
CORPORATION

# FORM 10-KSB FOR YEAR ENDED
DECEMBER 31, 2003

# ExhibitNumber    Description

|3.1 |  | Amended
and Restated  Articles of  Incorporation of the  Registrant--incorporated  by reference
                    to Exhibit 2.3 to the Registrant's Current Report on Form 8-K filed
on August 15, 2002
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.2 |  | Amended
and  Restated  Bylaws of the  Registrant--incorporated  by  reference to Exhibit 2.4 to
                    the Registrant's Current Report on Form 8-K filed on August 15, 2002
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.1 |  | Employment
  agreement   dated   January  1,  1991   between  the   Registrant   and  Elwin  M.
                    Beaty--incorporated  by  reference to Exhibit 10.1 to the
 Registrant's  Quarterly  Report Form                     10-QSB for quarter ended
September 30, 2002**
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 |  | License
 Agreement  dated November 16, 1990 between the  Registrant,  Elwin M. Beaty and Elaine
                    E.  Beaty--incorporated  by reference to Exhibit 10.2 to the
Registrant's Quarterly Report Form                     10-QSB for quarter ended September
30, 2002
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.3 |  | Agreement
 dated  April  19,  2002  among  the  Registrant,  Elwin M.  Beaty  and David P. Mork
                    relating  to  forgiveness  of   salary--incorporated  by  reference
 to  Exhibit  10.3  to  the                     Registrant's Quarterly Report Form 10-QSB
for quarter ended September 30, 2002
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.4 |  | Lease
 Agreement  dated  December 7, 2000 between  Registrant  and Carleton  Investors,  L.L.C.
                    relating to  Registrant's  Arizona  premises--incorporated  by
reference to Exhibit 10.4 to the                     Registrant's Quarterly Report Form
10-QSB for quarter ended September 30, 2002
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.5* |  | Amendment
 to Lease dated  December 15, 2003 and Second  Amendment  to Lease dated  January 21,
                    2004 between  Registrant  and  Carleton  Investors,  L.L.C.  relating
to  Registrant's  Arizona                     premises
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.6* |  | Amendment
to Lease  Agreement  dated  November 21, 2003 between  Registrant and Parkers Lake II
                    Realty Corp. relating to Registrant's Minnesota premises
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|11* |  | Statement
Regarding Computation of Earnings Per Share
|--- |  | -----------------------------------------------------

|21 |  | Subsidiary
 of the  Registrant--incorporated  by  reference  to Exhibit 21 to the  Registrant's
                    Quarterly Report Form 10-QSB filed on November 14, 2002
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|31* |  | Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|--- |  | -----------------------------------------------------------------------

|32* |  | Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|--- |  | -----------------------------------------------------------------------

| | *Filed herewith.
**Management agreement or compensatory plan or arrangement.
| | ----------------------------------------------------------------------------

21

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INDEPENDENT AUDITORS REPORT

Board of Directors and Stockholders
Scanner Technologies Corporation
Minneapolis, Minnesota

We have audited the accompanying
consolidated balance sheets of Scanner Technologies Corporation and Subsidiary as of
December 31, 2003 and 2002, and the related consolidated statements of operations,
stockholders equity and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial statements based
on our audits.

We conducted our audits in
accordance with auditing standards generally accepted in the United States of America.
Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the consolidated financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated 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
financial position of Scanner Technologies Corporation and Subsidiary as of December 31,
2003 and 2002, and the results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the United
States of America.

/s/   Lurie Besikof Lapidus & Company LLP
Lurie Besikof Lapidus & Company LLP

Minneapolis, Minnesota
February 13, 2004

F-1

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

|                                                             | December 31,
|------------------------------------------------------------ | ------------
|
|ASSETS                                                       |             
|CURRENT ASSETS                                               |             
|Cash                                                         |             
|Accounts receivable, less allowance of $40,000               |             
|Income taxes receivable                                      |             
|Inventory, less allowances of $20,000 and $32,000            |             
|Prepaid expenses                                             |             
|                                                             |             
|TOTAL CURRENT ASSETS                                         |             
|PROPERTY AND EQUIPMENT, net                                  |             
|PATENT RIGHTS, net                                           |             
|OTHER                                                        |             
|                                                             |             
|                                                             |             
|                                                             |             
|LIABILITIES AND STOCKHOLDERS EQUITY                         |             
|CURRENT LIABILITIES                                          |             
|Bank line of credit                                          |             
|Notes payable                                                |             
|Accounts payable                                             |             
|Accrued expenses                                             |             
|Customer deposits                                            |             
|                                                             |             
|TOTAL CURRENT LIABILITIES                                    |             
|                                                             |             
|COMMITMENTS AND CONTINGENCIES                                |             
|STOCKHOLDERS EQUITY                                         |             
|Preferred stock, no par value, 50,000,000 shares authorized; |             
|no shares issued and outstanding                             |             
|Common stock, no par value, 50,000,000 shares authorized;   
|10,426,459 and 10,000,982 shares issued and outstanding      |             
|Warrants                                                     |             
|Deferred financing costs, net                                |             
|Notes receivable for common stock                            |             
|Accumulated deficit                                          |             
|                                                             |             
|                                                             |             
|                                                             |             
|                                                             |             
|                                                             |             

See notes to consolidated
financial statements.

F-2

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                       | Year Ended December 31,
|-------------------------------------- | -----------------------
|
|REVENUES                               |                        
|COST OF GOODS SOLD                     |                        
|                                       |                        
|GROSS PROFIT                           |                        
|                                       |                        
|OPERATING EXPENSES                     |                        
|Selling, general and administrative    |                        
|Research and development               |                        
|Legal fees                             |                        
|                                       |                        
|                                       |                        
|                                       |                        
|LOSS FROM OPERATIONS                   |                        
|OTHER INCOME (EXPENSE)                 |                        
|Other income, net                      |                        
|Interest expense                       |                        
|                                       |                        
|LOSS BEFORE INCOME TAXES (BENEFIT)     |                        
|INCOME TAXES (BENEFIT)                 |                        
|                                       |                        
|NET LOSS                               |                        
|                                       |                        
|NET LOSS PER SHARE  BASIC AND DILUTED |                        
|                                       |                        
|WEIGHTED AVERAGE SHARES OUTSTANDING   |                        
|BASIC AND DILUTED                      |                        

See notes to consolidated
financial statements.

F-3

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

|                                              | Common Stock |  | AdditionalPaid-inCapital |            | Warrants |   | DeferredFinancingCosts |   | NotesReceivable |            | StockOptions |   | DeferredStockOptionCompensation |   | AccumulatedDeficit |          | Total |  
|--------------------------------------------- | ------------ |  | ------------------------ | ---------- | -------- | - | ---------------------- | - | --------------- | ---------- | ------------ | - | ------------------------------- | - | ------------------ | -------- | ----- | -
|
|                                              |              |  |                          |            |          |   |                        |   |                 |            |              |   |                                 |   |                    |          |       |  
|BALANCE AT DECEMBER 31, 2001                  |              |  |                          | 7,061,196  |          | $ | 70,612                 |   | $               | 1,262,023  |              | $ |                                |   | $                  |         |       | $
|Net loss                                      |              |  |                          |           |          |   |                       |   |                 |           |              |   |                                |   |                    |         |       |  
|Unearned compensation forgiven, net of tax    |              |  |                          |           |          |   |                       |   |                 | 818,575    |              |   |                                |   |                    |         |       |  
|Stock options:                                |              | 
|Repurchased for cash                          |              |  |                          |           |          |   |                       |   |                 |           |              |   |                                |   |                    |         |       |  
|Cancelled                                     |              |  |                          |           |          |   |                       |   |                 |           |              |   |                                |   |                    |         |       |  
|Exercised                                     |              |  |                          | 507,000    |          |   | 5,070                  |   |                 | 935,680    |              |   |                                |   |                    |         |       |  
|Amortization of deferred compensation         |              |  |                          |           |          |   |                       |   |                 |           |              |   |                                |   |                    |         |       |  
|Common stock issued for merger with           |              | 
|Southwest Capital Corporation                 |              |  |                          | 2,001,388  |          |   | (27,019                | ) |                 |           |              |   |                                |   |                    |         |       |  
|Additional shares issued for recapitalization |              |  |                          | 431,398    |          |   |                       |   |                 |           |              |   |                                |   |                    |         |       |  
|Change from par value to no par value         |              |  |                          |           |          |   | 3,016,278              |   |                 | (3,016,278 | )            |   |                                |   |                    |         |       |  
|                                              |              |  |                          |            |          |   |                        |   |                 |            |              |   |                                 |   |                    |          |       |  
|BALANCE AT DECEMBER 31, 2002                  |              |  |                          | 10,000,982 |          |   | 3,064,941              |   |                 |           |              |   |                                |   |                    |         |       |  
|Net loss                                      |              |  |                          |           |          |   |                       |   |                 |           |              |   |                                |   |                    |         |       |  
|Common stock issued for cash                  |              |  |                          | 100,000    |          |   | 250,000                |   |                 |           |              |   |                                |   |                    |         |       |  
|Warrants:                                     |              | 
|Issued                                        |              |  |                          |           |          |   |                       |   |                 |           |              |   | 574,671                         |   |                    | (574,671 | )     |  
|Exercised                                     |              |  |                          | 325,477    |          |   | 813,587                |   |                 |           |              |   | (163,110                        | ) |                    |         |       |  
|Amortization of deferred financing costs      |              |  |                          |           |          |   |                       |   |                 |           |              |   |                                |   |                    | 397,849  |       |  
|                                              |              |  |                          |            |          |   |                        |   |                 |            |              |   |                                 |   |                    |          |       |  
|BALANCE AT DECEMBER 31, 2003                  |              |  |                          | 10,426,459 |          | $ | 4,128,528              |   | $               |           |              | $ | 411,561                         |   | $                  | (176,822 | )     | $
|                                              |              |  |                          |            |          |   |                        |   |                 |            |              |   |                                 |   |                    |          |       |  

See notes to consolidated financial statements.

F-4

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                            | Year Ended December 31,
|--------------------------------------------------------------------------- | -----------------------
|
|OPERATING ACTIVITIES                                                        |                        
|Net loss                                                                    |                        
|Adjustments to reconcile net loss to net cash used by operating activities: |                        
|Depreciation                                                                |                        
|Amortization of deferred financing costs                                    |                        
|Amortization of patent rights                                               |                        
|Interest expense added to debt principal                                    |                        
|Deferred income taxes                                                       |                        
|Deferred stock option compensation                                          |                        
|Changes in operating assets and liabilities:                                |                        
|Accounts receivable                                                         |                        
|Income taxes receivable                                                     |                        
|Inventory                                                                   |                        
|Prepaid expenses and other                                                  |                        
|Accounts payable                                                            |                        
|Accrued expenses                                                            |                        
|Customer deposits                                                           |                        
|                                                                            |                        
|Net cash used by operating activities                                       |                        
|                                                                            |                        
|INVESTING ACTIVITY                                                          |                        
|Purchases of property and equipment                                         |                        
|                                                                            |                        
|FINANCING ACTIVITIES                                                        |                        
|Net proceeds on bank line of credit                                         |                        
|Proceeds from notes payable                                                 |                        
|Payments on notes payable                                                   |                        
|Proceeds from sale of common stock and exercise of warrants and             |                        
|stock options                                                               |                        
|Refund of stock options issued for cash                                     |                        
|                                                                            |                        
|Net cash provided by financing activities                                   |                        
|                                                                            |                        
|NET INCREASE (DECREASE) IN CASH                                             |                        
|CASH                                                                        |                        
|Beginning of year                                                           |                        
|                                                                            |                        
|End of year                                                                 |                        
|                                                                            |                        
|Supplemental Disclosures of Cash Flow Information:                          |                        
|Cash paid for:                                                              |                        
|Interest                                                                    |                        
|Income taxes                                                                |                        
|Noncash operating, financing and investing activities:                      |                        
|Warrants issued in connection with line of credit                           |                        
|Warrants exercised                                                          |                        
|Notes receivable issued for purchase of common stock                        |                        
|Unearned compensation forgiven and transferred to capital                   |                        
|Deferred tax asset related to forgiven unearned compensation                |                        
|Valuation of stock options exercised and cancelled                          |                        
|Stock options cancelled                                                     |                        
|Note payable issued in exchange for patent rights                           |                        
|Accrued license fees transferred to note payable                            |                        
|Officer loan offset against note payable                                    |                        
|Deficiency of Southwest Capital at date of merger                           |                        

See notes to consolidated financial statements.

F-5

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|1. |  | Basis
of Presentation and Significant Accounting Policies 
|-- |  | -----------------------------------------------------------

| | The accompanying
consolidated financial statements account for the merger between Scanner
Technologies Corporation (Scanner) and Southwest Capital Corporation (Southwest)
as a capital transaction in substance (and not a business combination of two
operating entities) that would be equivalent to Scanner issuing securities to
Southwest in exchange for the net monetary liabilities of Southwest, accompanied
by a recapitalization (See Note 2). The combined entity of Scanner and its
subsidiary and Southwest are referred to as the Company.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Nature of Business
| | ------------------

| | The
Company invents, develops and markets vision inspection devices that are used in the
semiconductor industry for the inspection of integrated circuits. The Companys
customer base is small in numbers and global in location.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Principles of
Consolidation
| | ---------------------------

| | The
consolidated financial statements include the accounts of Scanner Technologies Corporation
and its wholly owned subsidiary, Scanner Technologies Corporation International,
incorporated in the United States and registered in Singapore. All significant
intercompany balances and transactions have been eliminated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
Recognition
| | -------------------

| | Revenue
is earned primarily through sales of test equipment to third party customers and also to a
distributor. For sales to the distributor, revenue is recognized upon shipment as the
distributor has no acceptance provisions and title passes at shipment. For sales to third
party customers, title passes at shipment, however the customer has certain acceptance
provisions relating to installation and training. These provisions require the Company to
defer revenue recognition until the equipment is installed and the customers
personnel are trained. The Company provides the training but does not install the
equipment. As a result, revenue is recognized for third party customers once the product
has been shipped, installed and customer personnel are trained. This process typically is
completed within two weeks to a month after shipment.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
Estimates
| | --------------------

| | The
preparation of these consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in the
consolidated financial statements and accompanying notes. Actual results could differ from
those estimates. Significant management estimates relate to the valuation allowance on
deferred tax assets and payables for legal fees (See Note 12).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Fair
Value of Financial Instruments
| | -----------------------------------

| | The
carrying amounts of financial instruments consisting of cash, receivables, bank line of
credit, notes payable, accounts payable, accrued expenses and customer deposits
approximate their fair values.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accounts
Receivable
| | -------------------

| | Accounts
receivable arise from the normal course of selling products on credit to customers. An
allowance for doubtful accounts has been provided for estimated uncollectable accounts.
Accounts receivable, historical bad debts, customer concentrations, customer
creditworthiness, current economic trends and changes in customer payment terms and
practices are analyzed when evaluating the adequacy of the allowance for doubtful
accounts. Individual accounts are charged against the allowance when collection efforts
have been exhausted.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-6

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|1. |  | Basis
of Presentation and Significant Accounting Policies  (continued)
|-- |  | -----------------------------------------------------------------------

| | Inventory
| | ---------

| | Inventory
is stated at the lower of cost or market with cost determined on the first-in, first-out
method. The Company has provided an allowance for estimated excess and obsolete inventory
equal to the difference between the cost of inventory and the estimated fair value based
on assumptions about future demand and market conditions.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Property and
Equipment
| | ----------------------

| | Property and
equipment are stated at cost less accumulated depreciation. Depreciation is
provided using accelerated methods. Leasehold improvements are amortized
straight-line over the lease term.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Patent
Rights
| | -------------

| | Patent
rights are stated at cost less accumulated amortization. Amortization is provided using
the straight-line method over six years, the deemed useful lives of the patents.
Accumulated amortization at December 31, 2003 and 2002 was $87,481 and $25,730,
respectively, and annual amortization is $61,751.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Long-Lived
Assets
| | -----------------

| | In
January 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. The
adoption of SFAS No. 144 did not have a significant impact on the Companys financial
statements. All long-lived assets are reviewed for impairment when events or changes in
circumstances indicate that the carrying value of the asset may not be recoverable. An
impairment loss is recognized when estimated discounted cash flows to be generated by
those assets are less than the carrying value of the asset. When impairment loss is
recognized, the carrying amount is reduced to its estimated fair value, based on
appraisals or other reasonable methods to estimate value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Product
Warranty
| | ----------------

| | The
Company provides an accrual for estimated incurred but unidentified product warranty
issues based on historical activity. The warranty accrual and related expenses were not
significant.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accounting
for Stock-Based Compensation
| | ---------------------------------------

| | In
December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148,
Accounting for Stock-Based CompensationTransition and Disclosure. SFAS
No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair-value-based
method of accounting for stock-based employee compensation. In addition, SFAS No. 148
requires expanded and more prominent disclosure in both annual and interim financial
statements about the method of accounting for stock-based employee compensation and the
effect of the method of reported results. The adoption of SFAS No. 148 did not have a
significant impact on the Companys financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company had
a stock-based employee compensation plan consisting of stock options. However,
it has not adopted a method under SFAS No. 123 to expense stock options and
continues to apply Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related
interpretations in accounting for stock options. Accordingly, any compensation
cost for stock options is measured as the excess, if any, of the fair market
value of the Companys stock at the measurement date over the
employees option exercise price. Any resulting compensation expense is
amortized ratably over the related vesting period. Options and warrants to
non-employees are accounted for as required by SFAS No. 123.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-7

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|1. |  | Basis
of Presentation and Significant Accounting Policies  (continued)
|-- |  | -----------------------------------------------------------------------

| | If
the Company recognized stock option compensation expense based on fair value at the date
of grant, consistent with the methods prescribed by SFAS No. 123, net loss and per share
disclosures would remain the same for the year ended December 31, 2003. For the year ended
December 31, 2002, net loss and per share disclosures would change to the pro forma
amounts below:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Net loss:                               |  |  |   |            |  
|--------------------------------------- |  |  | - | ---------- | -
|As reported                             |  |  | $ | (2,020,149 | )
|Stock option amortization cost          |  |  |   | (15,433    | )
|                                        |  | 
|Pro forma                               |  |  | $ | (2,035,582 | )
|                                        |  | 
|Net loss per share  basic and diluted: |  | 
|As reported                             |  |  | $ | (.24       | )
|Stock option amortization cost          |  |  |   | (.01       | )
|                                        |  | 
|Pro forma                               |  |  | $ | (.25       | )
|                                        |  | 

| | Income
Taxes
| | ------------

| | The
Company is taxed as a domestic U.S. corporation under the Internal Revenue Code. Income
taxes are accounted for under SFAS No. 109, Accounting for Income Taxes.
Deferred income tax assets and liabilities are recognized for the expected future tax
consequences of events that have been included in the consolidated financial statements or
tax returns. Deferred income tax assets and liabilities are determined based on the
differences between the financial statement and tax bases of assets and liabilities using
currently enacted tax rates in effect for the years in which the differences are expected
to reverse. Deferred tax assets are evaluated and a valuation allowance is established if
it is more likely than not that all or a portion of the tax asset will not be utilized.
Income tax benefit is the current tax refundable for the year and the change during the
year in deferred tax assets and liabilities.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Credit
Risk
| | -----------

| | Significant
concentrations of credit risk exist in accounts receivable, which are due from customers
located primarily in the Far East and the United States.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Reclassifications
| | -----------------

| | Certain
reclassifications were made to the 2002 financial statements to make them comparable with
2003. The reclassifications did not affect previously reported stockholders equity,
net loss, or net cash flows.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Net
Loss Per Share
| | ------------------

| | Basic
net loss per share is computed by dividing the net loss by the weighted-average common
shares outstanding during the year. Diluted net loss per share normally includes common
stock equivalents (options and warrants), but they were excluded since their effect was
antidulitive.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Options
and warrants to purchase 3,015,289 and 1,385,716 shares of common stock with a weighted
average exercise price of $1.44 and $1.12 were excluded from the diluted computation for
the years ended December 31, 2003 and 2002, respectively, because they were antidulitive.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Recently
Issued Accounting Pronouncements
| | -----------------------------------------

| | On
January 1, 2003, the Company adopted SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS No. 146 requires the recognition of a
liability for a cost associated with an exit or disposal activity when the liability is
incurred versus the date the Company commits to an exit plan. In addition, SFAS No. 146
states the liability should be initially measured at fair value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-8

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|1. |  | Basis
of Presentation and Significant Accounting Policies  (continued)
|-- |  | -----------------------------------------------------------------------

| | On
July 1, 2003, the Company adopted SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 1, 2003, the Company adopted SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
requires issuers to classify as liabilities (or assets in some circumstances) three
classes of freestanding financial instruments that embody obligations of the issuer.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 1, 2002, the Company adopted FASB Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 elaborates on existing
disclosure requirements for most guarantees, including loan guarantees. It also clarifies
that, at the time of issuance of a guarantee, the Company must recognize an initial
liability for the fair value, or market value, of the obligations it assumes. The
liability recognition provisions do not apply to product warranties or to guarantees
accounted for as derivatives.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
adoption of the preceding Statements and Interpretation did not impact the Companys
consolidated financial statements for the years presented.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest
Entities. FIN No. 46 changes the criteria by which one company includes another
entity in its consolidated financial statements. FIN No. 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entitys activities or entitled to receive a
majority of the entitys residual returns or both. A company that consolidates a
variable interest entity is called the primary beneficiary of that entity. Previously, the
criteria was based on control through voting interest.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 2003, the FASB revised certain elements of FIN No. 46 and also modified its
effective date. For registrants who file under Regulation S-B, FIN No. 46 is applied in
periods ending after December 31, 2003. Since the Company does not have any variable
interest entities, this Interpretation is not expected to have any impact on its
consolidated financial statements.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. |  | Merger
and Reorganization 
|-- |  | ---------------------------

| | On
January 16, 2002, the Company executed an Agreement and Plan of Reorganization with
Southwest Capital Corporation (Southwest), a public company with no operations. The
agreement provided for the Company to merge into Southwest, with Southwest continuing as
the surviving corporation under the name of Scanner Technologies Corporation. On July 31,
2002, the Company completed its merger with Southwest pursuant to which the Company was
merged with and into Southwest. This merger was treated as a recapitalization.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
the effective date of the merger, each of the 7,568,196 shares of Scanners common
stock outstanding was converted into the right to receive 1.057 shares of the surviving
companys common stock and a five-year warrant to purchase 0.2642 shares of the
surviving companys common stock. The warrants are exercisable immediately at an
exercise price of $1.00 per share. The conversion ratio was based on the total amount of
Scanners common stock outstanding at the effective date of the merger. As a result,
the surviving company issued an additional 7,999,594 shares of its common stock and
warrants to purchase 1,999,543 shares of common stock. Each share of common stock of
Southwest issued and outstanding, 2,001,388 shares, remained issued and outstanding and
unaffected by the merger. Southwest had a deficiency in assets of $27,019 at the date of
the merger.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-9

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|2. |  | Merger
and Reorganization  (continued)
|-- |  | ---------------------------------------

| | At
the time of the merger, Scanner had outstanding warrants to purchase 225,000 shares of its
common stock at $2.75 per share. These warrants were converted into warrants to purchase a
total of 297,225 shares of common stock which consisted of a total of 59,445 units of the
surviving companys securities at $10.80 per unit, each unit consisting of four
shares of the surviving companys common stock and a five-year warrant immediately
exercisable to purchase one share of the surviving companys common stock at $1.00
per share.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
the time of the merger, the Articles of Incorporation were amended to authorize preferred
stock, increase the number of shares the Company is authorized to issue and to change the
common stock from $.01 par value to no par value stock.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
the consummation of the merger of Scanner into Southwest, the Company became the owner of
the licensed know-how in exchange for a secured note payable to the licensor
(officer/stockholder) for $1.00 and all expenses incurred for securing and maintaining the
intellectual property patent rights, totaling $370,505. The exclusive license agreement,
which was terminated, covered the operation, manufacturing, testing and selling of Scanner
products. The agreement required a fee of 5% of the Companys sales. License expense
was $38,773 for the year ended December 31, 2002.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following unaudited pro forma consolidated financial information for the year ended
December 31, 2002, provided for informational purposes only, assumes the merger of Scanner
and Southwest occurred on January 1, 2002. It is based on historical information and does
not necessarily reflect the actual results that would have occurred.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Revenues                                      |  |  | $ | 1,241,215  |  
|--------------------------------------------- |  |  | - | ---------- | -
|Net loss                                      |  |  |   | (1,754,770 | )
|Net loss per common share - basic and diluted |  |  |   | (.18       | )

|3. |  | Inventory

|-- |  | -----------

| | Inventory
consists of the following:
| | ------------------------------------

|                                                      | December 31,
|----------------------------------------------------- | ------------
|
|Finished goods                                        |             
|Subassemblies                                         |             
|Raw materials, less allowances of $20,000 and $32,000 |             
|                                                      |             
|                                                      |             
|                                                      |             

|4. |  | Property
and Equipment 
|-- |  | ------------------------

| | Property
and equipment consist of the following:
| | ------------------------------------------------

|                              | December 31, |  | EstimatedUsefulLives  Years
|----------------------------- | ------------ |  | ----------------------------
|
|                              |              |  |                             
|Furniture and fixtures        |              |  | $                           
|Machinery and equipment       |              |  |                             
|Leasehold improvements        |              |  |                             
|                              |              |  |                             
|                              |              |  |                             
|Less accumulated depreciation |              |  |                             
|                              |              |  |                             
|                              |              |  | $                           
|                              |              |  |                             

F-10

---

SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|5. |  | Bank
Line of Credit 
|-- |  | ---------------------

| | In
2003, the Company renewed its bank line of credit through May 1, 2004. The line was
increased from $900,000 to $1,300,000 with an interest rate at prime (4.00% and 4.25% at
December 31, 2003 and 2002, respectively), and the Company provided the bank with a
security interest in its general business assets. The line is guaranteed by individuals
who received for their financial support: (a) five-year warrants to purchase 325,000
shares of the Companys common stock at $2.75 per share and (b) thirty-day warrants
to purchase an additional 325,000 shares of the Companys common stock at $2.00 per
share. Provided the guarantor paid cash for at least one half of the shares subject to
their thirty-day warrant, such guarantor was permitted to purchase the remainder of the
shares with a promissory note, collateralized by the shares purchased, payable one year
from date of exercise. The guarantors exercised all such warrants in exchange for
aggregate cash payments to the Company of $350,000 and one year promissory notes issued to
the Company with an aggregate principal amount of $300,000. One of the promissory notes in
the amount of $25,000 was paid in August 2003. The remaining principal amounts are due in
April and May 2004. In connection with the exercise of their thirty-day warrants, the
guarantors were granted two-year warrants to purchase an additional 650,000 shares of the
Companys common stock at $2.00 per share. All of the warrants issued to the
guarantors had a market value of $574,671 as determined by the Black-Scholes option
pricing model.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
former bank line of credit was guaranteed by stockholders who received, in 2002, for their
financial support, warrants to purchase a total of 225,000 shares of the Companys
common stock at $2.75 per share. In the subsequent merger (See Note 2), the warrants were
converted into warrants to purchase a total of 59,445 units of the Companys
securities at $10.80 per unit, each unit consisting of four shares of the Companys
common stock and a warrant to purchase one share of the Companys common stock at
$1.00 per share.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. |  | Notes Payable

|-- |  | ---------------

| | Notes payable
consist of the following:
| | ---------------------------------------

|                                           | December 31,
|------------------------------------------ | ------------
|
|President, 8.00%, due August 2, 2003       |             
|Others, unsecured:                         |             
|Note payable, 4.25%, due April 8, 2004     |             
|Note payable, non-interest bearing, demand |             
|                                           |             
|                                           |             
|                                           |             

| | In
connection with the $100,000 note payable issued in 2003, the Company also issued
three-year warrants to purchase 25,000 shares of common stock at $2.75 per share. The
warrants had no market value as determined by the Black-Scholes option pricing model.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
note payable to the President was collateralized by all assets of the Company. Interest on
this note was $14,878 and $10,417 for 2003 and 2002, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|7. |  | Stockholders Equity 
|-- |  | ----------------------

| | Private Placement Offering
| | --------------------------

| | During
2003, the Company sold 100,000 shares of common stock at $2.50 per share, for an aggregate
amount of $250,000, under a private placement offering. Warrants to purchase an additional
25,000 shares of common stock at $3.00 per share were issued in connection with these
sales. The warrants expire three years after issuance and had no market value as
determined by the Black-Scholes option pricing model.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-11

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SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|7. |  | Stockholders Equity  (continued)
|-- |  | ----------------------------------

| | Stock Options
| | -------------

| | The Company
granted stock options under the Companys 1991 Stock Options and Stock
Award Plan (Plan Options) and sold stock purchase options to outside investors
(Financing Options). The 1991 Stock Options and Stock Award Plan was terminated
in 2002.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Prior
to 2002, the Company sold for cash 24,750 Financing Options at $.61 per share, which was
refunded in 2002.
| | ----------------------------------------------------------------------------------------------------------------

| | Stock
option activity for the year ended December 31, 2002 was as follows:
| | --------------------------------------------------------------------------

|                  | Options |  | Weighted-AverageExercise Price
|----------------- | ------- |  | ------------------------------
|                  |         |  |                               
|Beginning of year |         |  |                               
|Cancelled         |         |  |                               
|Exercised         |         |  |                               
|                  |         | 
|End of year       |         |  |                               
|                  |         | 

| | Stock
Warrants
| | --------------

| | The
Company issued warrants related to line of credit financing, services, issuances of common
stock and its merger and reorganization.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | In
2003, the Company issued five-year warrants to purchase 250,000 shares of common stock at
$1.35 per share in exchange for professional services related to financing arrangements.
The warrants had no market value as determined by the Black-Scholes option pricing model.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Warrant
activity was as follows:
| | --------------------------------

|                          | Warrants |  | Weighted-AverageExercise Price
|------------------------- | -------- |  | ------------------------------
|
|
|Beginning of year         |          |  |                               
|Issued                    |          |  |                               
|Merger and reorganization |          |  |                               
|Exercised                 |          |  |                               
|                          |          |  |                               
|End of year               |          |  |                               
|                          |          |  |                               

| | The
weighted-average grant-date fair value for warrants issued is as follows:
| | -----------------------------------------------------------------------------

|                                       | 2003 |  | 2002
|-------------------------------------- | ---- |  | ----
|
|                                       |      |  |     
|Warrant price less than stock price    |      |  |     
|Warrant price greater than stock price |      |  |     
|                                       |      |  |     
|                                       |      |  |     
|                                       |      |  |     

| | All warrants
outstanding at December 31, 2003 were exercisable and had a
weighted-average remaining life of 3.3 years.
| | ----------------------------------------------------------------------------------------------------------------------

F-12

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SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|7. |  | Stockholders Equity  (continued)
|-- |  | ----------------------------------

| | The fair value
of warrants is estimated at grant-date using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

|                        | Year Ended December 31,
|----------------------- | -----------------------
|
|Risk-free interest rate |                        
|Expected life-years     |                        
|Expected volatility     |                        
|Expected dividend rate  |                        

| | Since
the Companys stock is thinly traded, volatility is set at 0% as permitted by SFAS
123.
| | ---------------------------------------------------------------------------------------------

|8. |  | Income
Taxes 
|-- |  | --------------

| | Income
taxes (benefit) consist of the following:
| | ------------------------------------------------

|         | Year Ended December 31,
|-------- | -----------------------
|
|Current  |                        
|Deferred |                        
|         |                        
|         |                        
|         |                        

| | Income tax
computed at the U.S. federal statutory rate reconciled to the effective tax rate
is as follows:
| | ----------------------------------------------------------------------------------------------------------

|                               | Year Ended December 31,
|------------------------------ | -----------------------
|
|Benefit at statutory tax rate  |                        
|Benefit of net operating loss  |                        
|Nondeductible interest expense |                        
|Change in valuation allowance  |                        
|Other                          |                        
|                               |                        
|                               |                        
|                               |                        

| | Significant
components of net deferred tax assets are as follows:
| | -----------------------------------------------------------------

|                            | December 31,
|--------------------------- | ------------
|
|Deferred tax assets:        |             
|Operating loss carryovers   |             
|Tax credit carryovers       |             
|Other temporary differences |             
|Valuation allowance         |             
|                            |             
|Net deferred tax            |             
|                            |             

| | The valuation
allowance was provided as it is probable the deferred tax asset will not be
realized. The valuation allowance increased by $16,600 and $479,200 in 2003 and
2002, respectively, primarily because of the Companys inability to utilize
net operating losses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company has
operating loss carryforwards of approximately $1,103,000 for U.S. federal income
tax purposes which expire through 2022.
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | State tax
effects are immaterial and not separately disclosed.
| | --------------------------------------------------------------

F-13

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SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|9. |  | Employee Benefit Plan 
|-- |  | -----------------------

| | The Company
maintains a 401(k) plan for its employees. The employees are allowed to
contribute to the Plan as provided under the law. Any matching contributions by
the Company are at the discretion of the Board of Directors. No matching
contributions have been made for the years ended December 31, 2003 and
2002.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10. |  | Commitments

|--- |  | -------------

| | Operating
Leases
| | ----------------

| | Facilities are
leased under operating leases expiring through 2007. The leases require monthly
base rents plus increases for operating expenses and/or property taxes as
defined in the leases. Total rent expense for all leases was approximately
$155,300 and $154,800 for 2003 and 2002, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Approximate
future minimum lease payments are as follows:
| | ---------------------------------------------------------

|Year |  | Amount
|---- |  | ------
|2004 |  |       
|2005 |  |       
|2006 |  |       
|2007 |  |       
|     |  |       
|     |  |       
|     |  |       

| | Employment Agreement
| | --------------------

| | The Company has
an employment agreement with its President and Chief Executive Officer at an
annual pay of $180,000. The agreement contains a provision that requires the
Company to pay an amount equal to the annual salary if he is terminated without
cause.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|11. |  | Major
Customers and Geographic Information 
|--- |  | --------------------------------------------

| | The following
table shows by major customer by country the percentage of revenues for the
respective years and the percentage of receivables at December 31 of the
respective years:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Major Customers
|---------------
|               
|
|
|A              
|B              
|C              
|D              
|E              
|F              
|G              

|Geographic Information          
|--------------------------------
|                                
|
|Revenues                        
|Singapore                       
|Taiwan                          
|Japan                           
|Others outside the United States
|United States                   
|                                
|                                
|                                
|Property and Equipment, net     
|United States                   
|Outside the United States       
|                                
|                                
|                                

F-14

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SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|12. |  | Contingencies and Uncertainty 
|--- |  | -------------------------------

| | In
an agreement dated April 19, 2002, the Companys President and Chief Executive
Officer (President) forgave the payment of his accrued salary and released the Company,
its successors, its officers and directors from any liability in connection with the
accrued salary. In exchange, the Company agreed that its President will receive certain
proceeds, if any, that Scanner may receive out of litigation involving patents that
Scanner had licensed. Under the agreement, the Company keeps 60% of any proceeds of the
currently ongoing litigation and pays its President 40% of such proceeds until the Company
has been reimbursed for all attorney fees and other expenses incurred in connection with
the current litigation, and its President has received the total of $1,254,575. If one
party receives all the amounts owing to such party before the other partys claim
under this provision is satisfied, the other party receives 100% of the proceeds until its
claim is satisfied. If any proceeds remain after such payment, the Companys
President receives 50% of such remainder. He also has a right to receive part of the
proceeds, if any, the Company may receive out of any subsequent litigation involving the
licensed patents. The Company keeps 60% of any such proceeds until its attorney fees and
other expenses incurred in connection with the current and any subsequent litigation have
been reimbursed, and its President receives 40% of any such proceeds until he has received
a total of $1,254,575 of the proceeds of the currently ongoing and any subsequent
litigation. If any proceeds of the subsequent litigation remain after such distribution,
the Company will pay 25% of such remaining proceeds to its President. The unearned
compensation forgiven ($1,254,575) less the related deferred tax benefit ($436,000) was
recorded as additional paid-in capital in stockholders equity.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | To
provide the Companys Senior Vice President with an incentive to continue his
employment with the Company, and to compensate him for compensation in recent years which
the Company believes was less than he might have received in a comparable position
elsewhere, the Senior Vice President was also a party to the agreement regarding the
distribution of litigation proceeds. The Company agreed to pay to him 20% of the remaining
proceeds, if any, Scanner receives out of any subsequent litigation as described above
involving the licensed patents, and that remain after the aforesaid payments to the
Company and its President have been made out of such proceeds.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2000, the Company instituted a lawsuit against a Belgian corporation for infringement of
two of its patents. The patents related to three-dimensional ball array inspection
apparatus and method. Discovery was completed in the case and a so-called Markman hearing
was held in November 2001. In June 2003, the Company and the Belgian corporation reached a
settlement concerning one illumination source inspection systems. Pursuant to the
settlement agreement, the Belgian corporation made a one-time payment of $400,000 to the
Company to settle all issues with regard to these one light source inspection systems. The
court found no infringement with regard to the two illumination source devices that the
Belgian corporation sold. The Company agreed to the settlement in order to allow it to
immediately appeal the courts ruling concerning inspection systems involving two
light sources, eliminating the need, delay and expense of a trial with regard to these
systems at this stage. The Company intends to continue to vigorously enforce its patent
rights and expects to incur significant additional expenses in 2004 to pursue their
appeal. The Company believes that any unfavorable decision will not have a material or
adverse effect on the consolidated financial statements. In connection with the
settlement, the Company paid its President $160,000 pursuant to the agreement noted above.
The $400,000 settlement less the $160,000 paid to the President is recorded at net in
other income in the consolidated financial statements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2002, the Company brought suit against two law firms that previously represented the
Company in the aforementioned patent litigation. The Company demanded a full and complete
accounting for the fees and expenses, the payment of which these firms demand in
connection with the patent litigation. The Company has paid the law firms $558,652 in
legal fees and costs. The law firms claim that the Company owes them an additional
$402,984. When the Company brought the patent suit, the law firms estimated that legal
fees and costs through the discovery stage of the patent litigation would be $447,000 to
$585,000. The Company, therefore, contends that it does not owe any further payments to
the defendants. At December 31, 2003 and 2002, the $402,984 is included in accounts
payable in the consolidated balance sheets.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-15

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SCANNER TECHNOLOGIES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|12. |  | Contingencies and Uncertainty  (continued)
|--- |  | -------------------------------------------

| | A trial was
conducted in December 2003 relating to the above legal fees dispute. In January
2004, the court held that, the number of hours billed by the Defendants
(law firms) was grossly excessive. In its ruling, the court reduced the
outstanding balance due the law firms by approximately $320,000. It is the
opinion of the Companys legal counsel that this decision will not be
appealed by the law firms. Consequently, Scanner will reflect the reduction in
accounts payable and record other income in its consolidated financial
statements for the quarter ending March 31, 2004.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-16

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