FORM 10-K

                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549
 (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, 1997 or

 [ ]      Transition report pursuant to Section 13 or 15(d) of
          the Securities Exchange Act of 1934

          For the transition period from       to____

 Commission file number  0-9919

                                    PSC Inc.
              ----------------------------------------------------
              Exact name of registrant as specified in its charter

 New York                                                    16-0969362
 --------                                                    ----------
 State or other jurisdiction of                            IRS Employer ID No.
 incorporation or organization

 675 Basket Road, Webster, New York                             14580
 ----------------------------------                             -----
 Address of principal executive offices                        zip code


 Registrant's telephone number, including area code:  716-265-1600


           Securities registered pursuant to Section 12(b) of the Act:
           -----------------------------------------------------------

                                      None
                                      ----

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

                          Common Stock, $.01 par value
                          ----------------------------
                                (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports)  and  (2)  has  been  subject  to such  filing
requirements for the past 90 days.

                                    Yes X      No
                                       ----      ----

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


As of March 23,  1998 the  aggregate  market  value of the voting  stock held by
non-affiliates  of  the  registrant  was  approximately   $105,126,966  (Assumes
officers, directors and any shareholder holding 5% of the outstanding shares are
affiliates.)

As of March 23, 1998, there were outstanding 11,575,894 shares of Common Stock.

Documents incorporated by reference:

     Portions  of  PSC  Inc.'s  Proxy   Statement  for  the  Annual  Meeting  of
Shareholders  to be held on May 7, 1998 are  incorporated  into Part III of this
Form 10-K.



<PAGE>

                                TABLE OF CONTENTS

                                     PART I
                                                                     PAGE
Item   1:  Business................................................    4
Item   2:  Properties..............................................   17
Item   3:  Legal Proceedings.......................................   17
Item   4:  Submission of Matters to a Vote of Security Holders.....   17
               Executive Officers of Registrant....................   18

                                     PART II

Item   5:  Market for Registrant's Common Equity and Related
           Security Holder Matters.................................   21
Item   6:  Selected Financial Data.................................   22
Item   7:  Management's Discussion and Analysis of Financial
           Condition and Results of Operation......................   23
Item   8:  Financial Statements and Supplementary Data.............   27
Item   9:  Changes in and Disagreements with Accountants
           on Accounting and Financial Disclosure..................   27

                                    PART III

Item  10:  Directors and Executive Officers of the Registrant......   27
Item  11:  Executive Compensation..................................   27
Item  12:  Security Ownership of Certain Beneficial Owners and
           Management..............................................   27
Item  13:  Certain Relationships and Related Transactions..........   28

                                     PART IV

Item  14:  Exhibits, Financial Statement Schedules and Reports
           on Form 8-K.............................................   29





<PAGE>
                                     PART I

                                ITEM 1: BUSINESS

COMPANY OVERVIEW

     PSC Inc., together with its subsidiaries, (the Company) was incorporated in
the State of New York in 1969.  The Company  manufactures  the world's  broadest
line of laser based  handheld and fixed  position bar code  readers,  verifiers,
integrated  sortation and point-of-sale (POS) scanning systems for the worldwide
Automatic  Identification and Data Capture (AIDC) market. The Company's products
serve  as the  "front  end" of  terminals  or  host  computers  and are  used to
identify, capture, process and transmit data. The Company has developed products
for  AIDC at  every  stage  of the  product  supply  chain  from  raw  material,
manufacturing   and  warehousing,   to  logistics,   transportation,   inventory
management  and POS. The  Company's  products are used  throughout  the world in
food, general retail, health care and other industries, and in government.

     The Company has positioned  itself within the AIDC industry by selling both
domestically   and   internationally.    International   sales   accounted   for
approximately  46%  of  the  Company's  1997  total  sales.  The  Company  has a
diversified customer base composed of original equipment  manufacturers  (OEMs),
value-added resellers (VAR's),  distributors,  system integrators and end users.
The  Company's  distribution  relationships  have  enabled it to  introduce  its
products  (generally  under non-PSC  labels) to new vertical  markets,  and have
fostered  the   development  of  strategic   relationships   with  leading  AIDC
participants and end users.  The Company  operates within one industry  segment:
automatic identification and data capture.

     In September 1997, the Company completed a private placement of Convertible
Preferred Shares with Hydra Investissements S.A., a Luxembourg corporation.  The
net proceeds to the Company from the offering  were $10.2  million.  The Company
used the  proceeds  for working  capital  purposes and to repay a portion of its
senior revolving credit facility.

     In 1996, the Company acquired  Spectra-Physics Scanning Systems Inc., TxCOM
S.A. and related  businesses  (Spectra).  Spectra is one of the world's  leading
manufacturers  of countertop and in-counter fixed position bar code scanners for
retail POS applications.  The purchase price was approximately  $140 million and
was  accounted  for as a  purchase  and is  included  in the  1996  Consolidated
Financial Statements since the date of acquisition.

     The Company's corporate headquarters are located in the Rochester, New York
suburb of Webster.  The Company designs,  manufactures,  sells,  distributes and
services its products from world-class  manufacturing facilities in Webster, New
York and Eugene,  Oregon.  The Company has sales and service  operations  in the
Americas, Europe, Asia and Australia.



<PAGE>
MARKETS

     The Company  currently  focuses on retail,  and  commercial  and industrial
applications for the AIDC market.

Retail

     The retail  segment  consists  of many  applications  of bar code  scanning
devices  used to track the flow of goods,  equipment,  employees  and  customers
throughout  the  retail  environment.  The  most  traditional  and  identifiable
application  of bar code scanners and scanning  systems is in front end checkout
applications,  such as in grocery stores, in which an employee uses a stationary
or  handheld  scanner to read  product  identifiers  encoded in a bar code.  The
retail segment has,  however,  expanded beyond this base with regard to both the
types of retail stores employing scanners and scanning systems,  and the uses to
which these  stores put the  scanners  and  scanning  systems.  Discount,  drug,
do-it-yourself,  convenience,  department  and  specialty  retail stores now use
scanners in such diverse ways as price verification,  shelf stocking,  inventory
tracking     and      replenishment,      receiving,      coupon     redemption,
promotion/merchandising and frequent shopper programs.

     The Company is currently  active in most retail  applications and sells its
countertop  and  in-counter  bar  code  scanners  to  customers  in most  retail
segments.  In  addition,  the Company has begun to target  systems-oriented  and
segment-specific  products.  One such product  currently  being  marketed by the
Company is U-Scan Express(TM),  an automated grocery store self-checkout  system
developed and licensed to the Company by Optimal  Robotics  Corporation.  U-Scan
Express(TM), which has been installed in several major supermarket chains and is
currently  being tested by several major national mass  merchandise  chains,  is
designed to permit supermarket customers to scan, bag and pay for purchases with
little or no assistance from store personnel.

Commercial and Industrial

     The  commercial   and  industrial   segment  is  comprised  of  commercial,
manufacturing,  warehousing  and  distribution  applications of bar code systems
within retail, service, manufacturing,  logistics, healthcare and transportation
businesses and  organizations.  These industries have adopted bar code standards
and  installed bar code systems in order to increase  productivity  and increase
the   reliability  of  data   transactions.   Automated   data   collection  and
communication  is now used, for example,  to track insurance forms and financial
documents,  record quality levels of manufactured items, sort parcels,  mail and
airline  baggage,  prepare  shipping  manifests  and  catalog  blood and  plasma
inventories. Automatic dimensioning of cartons allows shippers to maximize loads
and more accurately  invoice  shipping costs. The Company is currently active in
several of these applications across a variety of market segments.

COMPANY PRODUCTS AND SERVICES

     The Company  offers a wide range of laser based bar code scanning  products
such as handheld, countertop, in-counter, fixed position and unattended scanners
and scan  engines  for use by  business,  industry  and  government  in multiple
application  areas. To ensure the quality of bar codes  themselves,  the Company
offers a full line of bar code  verifiers.  In addition,  the Company  markets a
full line of  accessories,  software and supplies to support its products.  This
line includes such items as cables, stands, printers, mounts, electronic article
surveillance  antennas,  AC power supplies,  product  documentation and software
configurations, carrying cases, batteries and battery chargers. An early entrant
in the AIDC industry,  the Company is committed to ongoing innovation in product
design, manufacturing, product performance and customer satisfaction.

<PAGE>

 The Company's products include:

Fixed Position Scanners:  Retail

360 Degree  Scanner  and  Scanner/Scale  (Magellan(R)).  The  Company  sells the
Magellan(R),  the industry's first 360 degree scanner and  scanner/scale and the
Company's  highest  performing  in-counter  scanner.  Magellan(R)  is capable of
simultaneously  reading the bottom and all four sides of grocery store items,  a
full 360 degrees,  thereby increasing  productivity and improving  ergonomics by
reducing  the need for  checkers  to twist,  turn or lift  items  for  scanning.
Magellan(R)  is available  with an  integrated,  30 pound  capacity  scale which
allows  retailers to combine the scanner and scale functions into a single unit.
Both the scanner and  scanner/scale  are designed for easy installation into new
and  existing   checkstands.   An  integrated  electronic  article  surveillance
deactivation antenna is also available for use in deactivating RF-based security
tags.  Magellan(R)  autodiscriminates  UPC/EAN  and up to three  industrial  bar
codes, and is available with advanced  Edge(TM)  decoding  software that enables
the scanner to read torn and disfigured  labels.  Magellan(R) also reads UPC/EAN
and Code 128 supplemental  codes, such as those found on books,  periodicals and
coupons.

Magellan SL(TM) Slim Line Scanner.  In 1997, the Company introduced the Magellan
SL(TM) SlimLine Series of 360 degree scanners and  scanner/scales.  The Magellan
SL(TM) is a  variant  of  Magellan(R),  and  offers  the same  capabilities  and
benefits as  Magellan(R).  One benefit unique to Magellan  SL(TM) is its smaller
size which  accommodates  installation  in the  narrower  checkstands  common in
Europe,  Asia and large cities  throughout  the world. A key feature of Magellan
SL(TM) is the L-shaped  All-Weighs(TM)  Platter. With the All-Weighs(TM) Platter
the scanner/scale's  vertical window and frame are an integral part of the scale
weighing platter, allowing checkers to lean oversized items against the vertical
window, intentionally or unintentionally, and get an accurate weight.

High Performance  Horizontal  Scanner (HS1250).  The Company sells the HS1250, a
compact,  high performance  horizontal scanner for grocery,  drug,  discount and
home improvement store applications. The HS1250 reads UPC/EAN and industrial bar
codes and features  advanced Edge(TM)  decoding  software.  It is also available
with  an  integrated   electronic  article   surveillance  antenna  for  use  in
deactivating RF based security tags. The scanner includes an integrated mount to
simplify  installation.  A sleep mode, which turns off the motor and laser after
periods of inactivity,  reduces power  consumption  and prolongs the life of the
scanner.

High Performance  Vertical  Scanners (VS1000 and VS1200).  The Company sells the
VS1000  and  VS1200  compact  vertical  scanners  which  include  scan  geometry
optimized  for vertical  scanning  applications  in limited  space areas such as
pharmacies,  variety and convenience stores.  These products permit bar codes to
be read  whether  the  handler  is  presenting  the bar code to the  scanner  or
sweeping  the bar code across the scanner in a continuous  movement.  The VS1000
autodiscriminates up to four bar code types and reads UPC/EAN and industrial bar
codes.  The VS1200,  in addition to the above features,  also  incorporates  the
Company's  advanced  Edge(TM) decoding  software.  The VS1200 is well suited for
performance  demanding  applications in supermarkets and hypermarkets.  Both the
VS1000 and VS1200 are available with an optional  integrated  electronic article
surveillance antenna for use in deactivating RF-based security tags.

Compact Scanners (Duet(TM) and SP*ACE(TM)).  The Duet(TM) Scanner,  announced in
1997,  is a  compact  "dual  action"  scanner  that  combines  features  of both
countertop  and handheld  scanners.  Standard  bar coded items are  presented or
swept by the  scanner's 19 line  omni-directional  scan  window.  Pick lists and
large,  bulky goods are easily processed using Duet's Targeted  Handheld Mode by
simply picking up the scanner and pointing it at a bar code.  With an innovative
scan pattern and a 9" depth of field,  Duet(TM) provides  superior  performance,
fast  throughput.  The  ergonomic  design  of  the  Duet(TM)  scanner  makes  it
exceptionally easy to use and easy on the user.
<PAGE>

SP*ACE(TM) is the Company's  smallest  fixed  position  scanner.  Because of its
compact size and multi-position  scan head, the SP*ACE(TM) scanner adapts easily
to a variety of retail and industrial  countertop or  wall-mounted  applications
where space and/or routing opportunities are limited. SP*ACE(TM) reads bar codes
up to eight inches away and  autodiscriminates  between up to four different bar
code types.

Retail Automation Systems

     The Company is currently  manufacturing and selling the U-Scan  Express(TM)
system,  a stand-alone  self-checkout  system,  to major  supermarkets  and mass
merchandisers  in the U.S.  Designed  and  licensed  to the  Company  by Optimal
Robotics  Corporation,  a Montreal  based  company,  the system is targeted  for
retail  store  express  lanes  and  incorporates  scanning,  interactive  video,
security  system and money  tendering  (cash,  credit or debit)  into a complete
stand-alone  unit.  The U-Scan  Express(TM)  is designed to permit  customers to
scan,  bag and pay for their own  purchases  with little or no  assistance  from
store personnel, thereby speeding checkout and improving store productivity.  To
date,  the U-Scan  Express(TM)  system has been  installed  in a number of major
supermarket   chains   nationwide  and   discussions  are  underway  for  future
installations with several large food and non-food retailers.

Handheld Scanners

Light  Industrial/Commercial  Scanners (5300 HP). The Company's high performance
5300 HP handheld  scanners are based on its 5301 scan engine platform.  The 5300
HP series was designed for the light  industrial,  commercial and special retail
environments  where  performance is critical.  These high  performance  scanners
provide snappy  scanning of "real world" bar code labels.  Depending on the size
and quality of bar codes, one model in the Series can read bar codes having bars
or spaces with a dimension as narrow as two  millimeters  (.002  inches).  A two
millimeter dimension bar code is common on small jewelry items or on the side of
a printed  circuit  board  which  can then be  tracked  through a  manufacturing
process.  A higher  powered laser in the 5300 HP series permits bar code reading
in bright  sunlight,  thereby allowing the operator to read through a windshield
for vehicle identification or through a glass showcase to read price tags.

Ruggedized  Industrial  Scanners (5300 IP). Like the 5300 HP, the Company's high
performance  5300 IP  handheld  scanners  are  based  on its  5301  scan  engine
platform.  The 5300 IP series scanners were designed for extreme  durability and
performance  for  jobs in  demanding  environments.  They are  ideal  for use in
warehouses,  distribution centers, automotive plants, utilities, in cold storage
warehouses and at chemical plants.  They can withstand rugged conditions such as
multiple  six-foot drops to concrete and temperatures as low as -22oF (-30oC) as
are  encountered  in walk-in  freezers.  In 1997,  the  Company  introduced  the
AutoRange(TM)  scanner which is essentially two scanners in one. This scanner is
ideally suited for warehouse and  distribution  center  applications for reading
bar code labels at long distances as well as up close.

5300 series  scanners are designed with an open slot in the scanner  handle that
accommodates  circuit  boards  with  additional  capabilities  such  as  decode,
interface   and   optional   memory,   thus   enabling   the  Company  to  offer
custom-manufactured scanners that OEMs then sell under their private labels. The
Company's  lifetime warranty on the scanning mechanism in each model of the 5300
series reflects the Company's confidence in the quality of these products.

<PAGE>

Retail,  POS Service and Commercial  Scanners  (Quick  Scan(TM) and SP400).  The
Quick  Scan(TM) is a full  feature,  full  function,  full  performance  scanner
incorporating the Company's smaller scan engine platforms. The Quick Scan GP(TM)
provides general performance scanning in lower volume POS,  point-of-service and
commercial  applications  with  consistent bar code placement and location.  The
Quick Scan HP(TM)  addresses the scanning  requirements for higher volume retail
and commercial applications where handling mixed and inconsistently marked items
requires greater  depth-of-field  and enhanced scanning  performance.  The Quick
Scan(TM) EP provides extended performance and longer range scanning applications
up to five feet.  The Quick  Scan(TM)  6000 was  designed  specifically  for the
retail POS and features an unprecedented  combination:  the superior performance
and rugged  design of a high end POS scanner,  priced  affordably.  Its advanced
ergonomic  design  was  developed  with  operator  comfort in mind -- a critical
factor that ensures prolonged operator productivity. The size and shape of Quick
Scan(TM) makes it comfortable to hold independent of handedness and hand size.

The SP400 offers  higher  performance  levels by combining a visible laser diode
light source,  patented signal processing  technology,  long  depth-of-field and
wide angle reading. The SP400 family includes a variety of models for retail and
industrial applications.  The SP400 EP (Extreme Performance) scanner is the only
handheld  scanner on the market to offer a true seal against  windblown dust and
rain. This feature,  combined with other enhancements to the housing,  gives the
SP400 EP the highest rating in the industry for ruggedness and  durability,  and
makes it ideal for outdoor use.

Specialty Handheld Scanners (538X Series). These specialty scanners offer custom
form factors and optics for unique  applications.  Included in this line are the
5380  Back-of-the-Hand   Scanner,  the  5381  Palm  Top  Scanner  and  the  5387
Scandle(TM).

The 5380  Back-of-the-Hand  Scanner  has a small  profile  and weighs only three
ounces,   making  it  particularly   suitable  for  "picking"   applications  in
distribution centers and other hands-free operations. This scanner, which allows
for  hands-free  scanning,  attaches to a comfortable  glove that can be worn on
either  hand and can be actuated  manually  with a trigger or  automatically  by
PSC's Autosense(R)  feature.  Hands-free scanning allows an operator to use both
hands to select items from shelves or racks and transmit  data  regarding  those
items to a data terminal.

The 5381 Palm Top Scanner,  compactly designed and weighing 4.8 ounces, is about
the  size of a TV  remote  control.  It can be used in  either  hand  and can be
slipped into a shirt pocket or attached to clothing with a Velcro(R)  patch when
not  in  use.  The  5381  is the  appropriate  choice  for  POS  and  industrial
applications where size, weight and accessibility are key factors.  Top and side
triggers  have been  provided to allow for ease of scanning  either  vertical or
horizontal bar codes by left or right handed operators.

The 5387 Scandle(TM) has the approximate  size,  weight and shape of a telephone
handset.  When snapped into place on a small  portable  computer,  such as those
carried by telephone  line  workers,  it functions  as the  computer's  carrying
handle.

Fixed Position Scanners:  Commercial and Industrial

Miniature Scanners.  The 9000 scanner is a compact,  versatile,  industrial line
scanner intended primarily for high-speed automated sorting or identification in
the demanding  environments of the  manufacturing and material handling markets.
Through the use of advanced digital signal processors,  this scanner can provide
scan rates of between  200 and 1500 scans per  second.  Both the scan engine and
the  decoder  may be  contained  in a single  unit.  Because  the scanner can be
programmed  either locally or from the host computer,  it provides the user with
maximum flexibility.

High-End  Line  Scanners.   The  series  8000  and  8000LX  provide  a  line  of
high-powered,  high-speed,  adjustable  rastering  line  scanners for  demanding
applications,  such as airline  baggage  handling,  overnight  package  delivery
sortation and other high-speed  sortation.  They can read bar code labels moving
at speeds of up to 500 feet per minute.  Features include auto-focusing and Time
Slice Decoding(TM) (TSD) which allows the scanner to read only
<PAGE>

a small portion of a code on each of several  successive  scans and  reconstruct
the  entire  bar code.  By  multiplexing  (interconnecting  two or more of these
scanners  having  varying  scanning  ranges),  a  system  can be  configured  to
simultaneously  read and  track bar  codes as they  move  past the  scanners  at
different distances.

Omnidirectional  Scanners.  The model 990  SureScan(R) is a high-speed  modular,
omnidirectional  scanner for use in large volume distribution centers. It may be
equipped with TSD software to read randomly  oriented bar codes as, for example,
labels on packages  tumbling down a chute at speeds up to 600 feet per minute at
a distance of 30 inches.  The model 990 can also be  configured  with up to four
multiplexed scanners.

Carton Dimensioning System. The SureCube(TM) is an automated carton dimensioning
system which measures the volume of cartons over  conveyors or in-motion  scales
for  material  handling  systems.  The  system can be  supplied  with a bar code
scanner for identifying  and  dimensioning or integrated with an in-motion scale
to provide a completely automated system for identifying,  sizing,  weighing and
sorting of cartons.  It captures  the carton data  regardless  of the  location,
orientation  or  angle  of the  carton.  This  is  especially  useful  in  large
warehouses, package delivery services and other shipping companies.

Scanning Tunnel Systems.  By using multiple  scanners oriented around a conveyor
belt, PSC offers a unique solution to solve high speed sortation  problems where
cartons may have a bar code label on any  surface of a carton,  even the bottom,
or multiple  labels on multiple sides of the carton.  With the  ScanManager(TM),
this system can track up to 16 cartons at one time at conveyor  speeds up to 300
feet per minutes.

Scan Engines

     The Company's scan engines are  self-contained  bar code reading components
which  OEMs  build  into a variety  of  products.  The  Company's  scan  engines
incorporate all of the electronic,  optical and mechanical  components  required
for laser  scanning  in a single  package  which can be easily  integrated.  The
various models  manufactured by the Company are based on either its 5301 "large"
platform,  the smaller 5303  version or the  miniaturized  Minuet(TM)  DI(TM) or
LM-500.  The 5301  platform  is about  the size of a deck of  playing  cards and
occupies a volume of 10 cubic  inches.  In response  to  industry  demands for a
smaller scanning platform,  the Company introduced the 5303 scan engine which is
about half the footprint of the 5301 and occupies 3.5 cubic inches.  The Company
introduced an even smaller scan engine,  the Minuet(TM) Direct  Illumination(TM)
bar code engine. This miniature engine has a volume of only 1.2 cubic inches. In
a Direct  Illumination(TM)  bar code  engine  system,  there  are no  reflective
optics; the laser is mechanically swept to directly illuminate the bar code. The
Minuet(TM)  DI(TM) can significantly  enhance bar code reading  performance in a
variety of OEM  products  such as  portable  data  collection  devices;  laptop,
handheld  and  palmtop  computers;  diagnostic  and test  equipment;  and ticket
issuing  machines.  The newest addition to the Minuet(TM)  scanner family is the
LM-500.  The LM-500  continues the progress toward  miniaturization  of scanning
engines.

Quick Check (R) Verifiers

     The Company's line of Quick  Check(R)  verifiers is designed to ensure that
the customer is producing,  using and receiving quality bar code symbols.  Quick
Check(R)  verifiers can display a simple  pass/fail report or provide a detailed
quality  analysis.  These verifiers are sold as handheld,  desktop,  PC based or
printer/labeler  mounted on-line models.  They analyze bar codes for traditional
print quality such as wide to narrow ratio, print contrast,  bar growth or loss,
dimensions and formats,  or analyze based upon quality  parameters  found in the
American  National  Standards   Institute  (ANSI)  and  European  Committee  for
Standardisation  (CEN)  guidelines  such  as  edge  determination,   reflectance
minimum,  symbol contrast,  modulation,  decodability and edge contrast minimum.
When mounted  on-line,  the Quick Check(R)  verifier  results can  automatically
control the user's system and cause it to pause,  reprint,  shutdown or activate
an alarm.  All Quick Check(R)  verifiers are designed and  manufactured  to meet
national,  international and industry specified standards (such as those created
by the Uniform  Code  Council and the  Automatic  Identification  Manufacturers,
Inc.) and provide  traceability  to the  National  Institute  of  Standards  and
Technology (NIST) for compliance to ISO 9000 and QS 9000 requirements.

<PAGE>
SALES AND MARKETING

     The Company sells its products  domestically and internationally  through a
diversified customer base composed of OEMs, third party resellers and end users.
International  sales increased from approximately  $19.3 million,  or 22% of net
sales,  in 1995 to  approximately  $95.2 million,  or 46% of net sales, in 1997.
Management  believes  that the  international  markets for bar code products are
less  developed  and  intends to broaden  its  international  sales and  provide
additional sales and marketing support to its international operations.

     The  Company's  OEM  customers  and third  party  resellers  serve  various
vertical markets and submarkets and a wide variety of end users.  They introduce
the Company's  products to their end users through their  established  sales and
distribution  networks,  thus  sparing the Company the expense of  supporting  a
large in-house sales force. By forming  strategic  relationships  with major OEM
customers,  the Company has been able to conduct  joint  development  and design
customer-specific  products  and  applications  and thereby  further  expand its
market presence and broaden its distribution network.

     In  addition  to its sales and  marketing  staff in  Webster,  New York and
Eugene,  Oregon,  the Company has regional sales  representatives  in the United
States  and sales  offices  throughout  Europe  and the Asia  Pacific  area that
provide sales,  service and support to the Company's  domestic and international
customers.

     Foreign sales of the Company's  products are subject to the normal risks of
foreign  operations,   such  as  currency   fluctuations,   protective  tariffs,
export/import controls and transportation delays and interruptions.  Because the
Company's  products are  manufactured in the United States,  the Company's sales
and results of operations  could be affected by fluctuations in the value of the
U.S. dollar.

     The Company's  marketing  operations  include  product  management,  market
management,  new business  development and marketing  communications.  Marketing
personnel identify new business opportunities,  develop business plans, identify
new product and market requirements, manage product positioning/introduction and
provide tactical sales support activities. They interact regularly with external
parties such as OEMs,  VARs,  distributors,  systems  integrators and end users,
technical partners and standards  committees.  The marketing  personnel also, in
conjunction  with  outside  vendors,  conduct  customer  surveys and  coordinate
advertising and public relations. This group creates advertising,  brochures and
documentation,  manages  trade show  exhibits and places  articles  highlighting
applications of the Company's products in trade and industry publications.

CUSTOMER SUPPORT AND SERVICE

     The Company is dedicated to providing consistently high customer service on
a national and  international  basis. The Company  maintains a highly responsive
customer support and service  organization that bridges the Company's marketing,
engineering  and  manufacturing  functions.  The  customer  support  and service
personnel receive extensive training in all of the Company's products and assist
customers with  ordering,  product  scheduling,  coordinating  service  repairs,
procuring  replacement parts and managing warranties and service contracts.  The
Company's Eugene,  Oregon customer service and support  organization has met ISO
9000 quality registration levels.

CUSTOMERS

     The  Company  sells  its  products  to OEMs,  VARs,  distributors,  systems
integrators  and end  users.  During  1997  and  1996,  no  individual  customer
accounted  for greater than 10% of net sales.  During 1995,  Telxon  Corporation
accounted for 17% of sales. No other customers were responsible for greater than
10% of net sales in 1995. The Company's  arrangements  with major  customers are
generally nonexclusive.
<PAGE>

ENGINEERING, RESEARCH AND PRODUCT DEVELOPMENT

     The Company's  engineering research and product development (ER&D) programs
are aimed at  applying  its  technology  to develop  new  products,  improve its
existing   products'   reliability,   ergonomics  and   performance  and  reduce
manufacturing and related support costs.  Current programs focus on new advances
in bar code scanning,  retail applications such as retail self-checkout  systems
and new  generations  of portable  data  terminals.  The Company also carries on
significant development programs in electronics design, bar code acquisition and
decoding,  RF  communications,   optical  signal  detection,  software,  network
architectures,   advanced  mechanical  structures  and  automated  manufacturing
methods. Computer-aided design and computer-aided manufacturing tools assist the
Company's research and development  efforts by permitting computer simulation of
proposed  products.  These tools include  electronics  circuit modeling,  optics
analysis and three-dimensional mechanical product modeling.

     Substantially all of the Company's research and development is performed by
its own staff. The Company believes its technical strengths are in the specialty
disciplines  of  lasers,  electro-optics,   video  imaging,  signal  processing,
decoding, portable/fixed computers and software development.

     The  Company's  ER&D  expenses  were  approximately  $13.0  million,  $11.1
million, and $5.0 million in 1997, 1996, and 1995, respectively. Such amounts do
not  include   expenditures  by  the  Company  for   manufacturing   engineering
activities.

MANUFACTURING AND SUPPLIERS

     The Company designs,  engineers and manufactures  substantially  all of its
scanning products at its Webster,  New York  headquarters or its Eugene,  Oregon
facility.   The  Company's  design  and  process  approach  allows   end-of-line
configuration of generic modules to meet a multitude of specific customer needs.
Statistical  methods are used throughout the factory and with critical suppliers
in order to control  important  processes.  The Company  makes  extensive use of
computer integrated systems and software for purposes of resource planning, such
as material requirements, assembly planning and scheduling and order management.

     The  Company  seeks  to  design  and  manufacture  products  that  optimize
performance,  quality,  reliability,  durability and versatility.  These designs
facilitate  cost-efficient  materials  sourcing and  assembly  methods with high
standards of  workmanship.  The Company has invested and will continue to invest
in capital  equipment such as printed  circuit board surface mount machines that
automate production,  increase capacity and reduce direct labor costs.  Computer
operated  equipment  is used for testing at all levels of  production  to assure
repeatable,  reliable performance and accurate data collection.  The Company has
designed many of its own tools, fixtures and test equipment.  The Quick Check(R)
product is manufactured by an independent  third party. The Company believes its
relationship   with  this  manufacturer  to  be  good,  and  the  loss  of  this
manufacturer would not have a material effect on the Company.

     The Company does not have long-term supply contracts with its vendors.  The
Company  currently  relies on single  suppliers,  some of whom  manufacture at a
number of  locations,  for some key  components  of its  products.  The  Company
believes that maintaining  ongoing  relationships with single suppliers who have
proven  that they are  capable of meeting the  Company's  standards  of quality,
on-time  delivery and cost  containment  has enabled it to increase the value of
its  product to its  customers.  Although  the  Company  maintains  30 to 60 day
inventories  of key  components  and  alternative  sources of key  materials are
available,  the Company  could incur  set-up  costs and delays in  manufacturing
should it  become  necessary  to  replace  key  vendors  due to work  stoppages,
shipping  delays,  financial  difficulty  or other  factors,  and under  certain
circumstances,  these costs and delays could have a material  adverse  effect on
the Company's operations.
<PAGE>

COMPETITION

     The AIDC industry is highly competitive with rapid technological change and
intellectual  property  developments being key competitive  factors. The Company
also competes on the basis of  innovative  design,  high quality  manufacturing,
technical  expertise  in scanning  and  wireless RF systems,  level of sales and
support services,  price and overall product  functionality and fitness for use.
Failure to keep pace with product and  technological  advances could  negatively
affect the Company's  competitive  position and prospects for growth. Many firms
manufacture and market bar code reading equipment utilizing laser technology. In
addition,  the Company's bar code reading  equipment  also competes with devices
which utilize  technologies  other than laser  scanners such as CCDs and optical
wands. The Company faces competitive pressures from various companies in each of
its product  categories.  Many of the Company's  competitors have  substantially
greater  financial,  manufacturing,   research  and  development  and  marketing
resources than the Company.  The Company believes its principal  competitors for
its handheld bar code scanner products are Symbol  Technologies,  Inc. (Symbol),
and  Metrologic   Instruments  Inc.   (Metrologic).   The  Company's   principal
competitors in the fixed position  scanner  market are Accu-Sort  Systems,  Inc.
(Accu-Sort) and CI/Matrix.  The Company  believes its principal  competitors for
its line of in-counter  and  on-counter  scanner  products are NCR  Corporation,
Fujitsu Ltd., Symbol,  Scantech B.V. and Metrologic.  The principal  competitors
for its line of verifiers  are Stratix  (formerly Bar Code Systems) and RJS Inc.
The Company's principal competitor for POS self-checkout systems is Productivity
Solutions, Inc.

     No  assurance  can be  given  that  the  Company  will be  able to  compete
successfully  against  current and future  competitors  or that the  competitive
factors  faced by the  Company  will not have a material  adverse  effect on the
Company's operations.

INTELLECTUAL PROPERTY

     The Company  believes  that  certain of its products  are  proprietary  and
consequently relies on a combination of United States and foreign patent,  trade
secret,  copyright and  trademark  law to establish and protect its  proprietary
rights. The Company currently holds more than 160 United States patents and also
has certain foreign patents pertaining to various  technologies  associated with
its products.  These patents  expire on various dates between 2003 and 2016. The
Company  currently  has a number of patent  applications  pending  in the United
States and in a number of foreign  countries.  In addition,  the Company expects
that its continuing research and development efforts will result in the creation
of new proprietary rights for which it will seek patent protection.

     The Company  maintains an active  program to obtain  patents and  otherwise
protect its intellectual property.  Nevertheless,  its competitors could develop
technology or know-how or obtain patents that could limit the Company's  ability
to compete in the future. Similarly,  others could challenge the validity of the
Company's  patents or assert that the Company is infringing on their proprietary
rights. The Company believes that its patents are valid and enforceable and does
not believe that it is infringing on the proprietary rights of others. While the
Company  believes that its patents provide it with  competitive  advantages with
respect to the  products  they cover,  the  Company  relies  primarily  upon the
technical know-how, competence, innovative skills and marketing abilities of its
engineers and other employees.

     The Company currently holds certain trademarks that are registered with the
United States Patent and Trademark  Office and a number of common law trademarks
and valuable  trade  secrets.  It also has certain  foreign  trademarks  and has
numerous domestic and foreign trademark registrations pending.

EMPLOYEES

     As of  March  1,  1998,  the  Company  had  approximately  1,150  full-time
employees.  In  addition,  the Company at various  times makes use of  temporary
labor in its  manufacturing  operations.  Approximately  8% of the work force is
located outside the United States,  based in offices  throughout  Europe and the
Asia Pacific  regions.  The Company believes that its future success will depend
in part on its  ability to recruit and  maintain  highly  qualified  management,
marketing,  technical  and  administrative  personnel.  None  of  the  Company's
employees  is  represented  by a  labor  union.  Management  believes  that  its
relationship with employees is good.

GOVERNMENT REGULATION

     Certain products of the Company must comply with regulations promulgated by
the  United  States  Food and  Drug  Administration's  Center  for  Devices  and
Radiological Health (CDRH), the Federal Communications Commission (FCC), as well
as the Canadian Standard Association,  the European Community Standards (CE) and
TUV Rheinland  (Europe),  which are  corresponding  agencies for certain foreign
countries. The regulations are in
<PAGE>



the areas of laser light  emissions,  intentional or  non-intentional  RF energy
emissions,  standards  for weighing  instruments  and  European  electromagnetic
compatibility  (EMC)  directives.  The regulations  mandate,  among other items,
warning labels,  safety features,  and establish certain levels for laser power,
weight measuring,  voltage and electromagnetic  fields. The Company's operations
are also subject to certain federal,  state and local  requirements  relating to
environmental,  waste  management,  health  and safety  regulations.  Management
believes that the Company's  business is operated in compliance  with applicable
government,  environmental,  waste  management,  health and safety  regulations.
There can be no assurance that future  regulations  will not require the Company
to modify its  products to meet  revised  energy  output or other  requirements.
Failure to comply with future  regulations  could  result in a material  adverse
effect on the Company's results of operations.

SAFE HARBOR FOR  FORWARD-LOOKING  STATEMENTS UNDER SECURITIES  LITIGATION REFORM
ACT OF 1995; CERTAIN CAUTIONARY STATEMENTS

     From time to time, the Company or its representatives have made or may make
forward-looking   statements,   orally  or  in  writing.   Such  forward-looking
statements  may be  included  in,  but not  limited  to,  press  releases,  oral
statements  made with the  approval  of an  authorized  executive  officer or in
various filings made by the Company with the Securities and Exchange Commission.
The words or phases "will likely  result," "are  expected to," "will  continue,"
"is anticipated,"  "estimate,"  "project" or similar expressions are intended to
identify  "forward-looking   statements"  within  the  meaning  of  the  Private
Securities Litigation Reform Act of 1995 (the Reform Act). The Company wishes to
ensure that such statements are accompanied by meaningful cautionary statements,
so as to maximize to the fullest  extent  possible the  protections  of the safe
harbor established in the Reform Act.

     Accordingly,  such  statements are qualified in their entirety by reference
to and are accompanied by the following  discussion of certain important factors
that could cause actual results to differ  materially from such  forward-looking
statements.The risks included here are not exhaustive. Furthermore, reference is
also made to other  sections of this report  which  include  additional  factors
which could adversely impact the Company's  business and financial  performance.
Moreover,  the Company  operates  in a very  competitive  and  rapidly  changing
environment.  New risk  factors  emerge from time to time and it is not possible
for management to predict all of such risk factors, nor can it assess the impact
of all of such risk factors on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from  those   contained   in  any   forward-looking   statements.   Accordingly,
forward-looking  statements  should not be relied upon as a prediction of actual
results.

     Shareholders  should be aware that  while the  Company  does,  from time to
time,  communicate with securities analysts,  it is against the Company's policy
to  disclose to such  analysts  any  material  non-public  information  or other
confidential commercial information. Accordingly, shareholders should not assume
that the  Company  agrees  with any  statement  or report  issued by any analyst
irrespective  of the content of such  statement or report.  Accordingly,  to the
extent that  reports  issued by  securities  analysts  contain any  projections,
forecasts or opinions, such reports are not the responsibility of the Company.


Spectra Acquisition/Debt  Service. The Company incurred substantial indebtedness
($127.5 million) in connection with the acquisition of Spectra. The indebtedness
could have important  consequences,  including the following:  (i) the Company's
ability  to obtain  additional  financing  in the future  for  working  capital,
capital  expenditures,   acquisitions  or  general  corporate  purposes  may  be
impaired;  (ii) a substantial portion of the Company's cash flow from operations
must be  dedicated  to the  payment of  interest  on the  indebtedness,  thereby
reducing  the funds  available  to the  Company  for other  purposes;  (iii) the
agreements  governing  the  Company's  long-term  indebtedness  contain  certain
restrictive  financial and operating covenants;  (iv) certain indebtedness under
the senior  debt will be at  variable  rates of  interest  which would cause the
Company  to be  vulnerable  to  increases  in  interest  rates;  (v)  all of the
indebtedness  outstanding  under the senior debt is secured by substantially all
the assets of the Company; (vi) the Company is substantially more leveraged than
certain of its  competitors  which  might  place the  Company  at a  competitive
disadvantage; (vii) the Company may be hindered in its ability to

<PAGE>

adjust  rapidly  to  changing   market   conditions  and  (viii)  the  Company's
substantial  degree of leverage could make it more  vulnerable in the event of a
downturn in general economic conditions or its business.

     As a result of the indebtedness incurred in connection with the acquisition
of Spectra, a substantial  portion of the Company's cash flow will be devoted to
debt  service.  The  ability  of the  Company to  continue  making  payments  of
principal  and  interest  will be largely  dependent  upon its future  financial
performance.

Technological  Change. The market for the Company's products is characterized by
rapidly changing  technology,  evolving industry standards,  changes in customer
requirements  and  frequent  new product  introductions  and  enhancements.  The
Company's  future  success  will  depend on its  ability to enhance  its current
products,  to develop new products on a timely and  cost-effective  basis and to
respond  to  changing  customer  requirements  and  technological  developments.
Certain of the  Company's  competitors  spend  larger  amounts on  research  and
development  efforts than the Company.  Any failure by the Company to anticipate
or respond adequately to changes in technology and customer preferences,  or any
significant delay in product development or introduction,  could have a material
adverse effect on the Company's  financial  condition and results of operations.
There can be no assurance  that the Company will be successful in developing and
marketing,  on a timely and cost-effective  basis,  product  enhancements or new
products  that  respond to  technological  advances by others,  or that such new
products or product enhancements will achieve market acceptance.

Dependence on Intellectual  Property Rights.  The Company's success is dependent
in part on its ability to obtain patent  protection  for its products,  maintain
trade secret protection and operate without infringing the proprietary rights of
others. The Company currently owns over 160 U.S. patents having expirations from
the year 2003 to the year 2016 and also has certain foreign patents. The Company
has filed, and intends to file, applications for additional patents covering its
products.  There can be no assurance that any of these patent  applications will
be granted,  or that the  Company  will  develop  additional  products  that are
patentable  and do not infringe upon the patents of others,  or that the patents
issued to or licensed by the Company will provide the Company with a competitive
advantage or adequate protection for its products. In addition,  there can be no
assurance  that  the  Company's  competitors  will  not  develop  technology  or
know-how,  to obtain patents,  that could limit the Company's ability to compete
in the future or that  patents  issued to or licensed by the Company will not be
challenged, invalidated or circumvented by others.

Pending Litigation. The AIDC industry is characterized by substantial litigation
regarding  patent  and  other   intellectual   property   rights.   The  Company
aggressively defends its patents and other proprietary rights.

     There is  litigation  pending in the United States  District  Court for the
Western  District of New York between the Company and one of its  customers,  on
the one hand, and Symbol  Technologies,  Inc.  (Symbol) on the other,  involving
certain of Symbol's  patents.  In that  action,  the  Company  has also  alleged
violation of the  antitrust  laws and unfair  practices by Symbol and Symbol has
alleged breaches of certain license  agreements  between the Company and Symbol,
including  claims  that  royalties  have been  underpaid.  The  Company has also
assumed the responsibility of defending the action on behalf of its customer and
has provided  certain  rights of  indemnification  to its customer.  The Company
intends to defend  itself and its  customer  vigorously.  Although  the  Company
maintains that Symbol's patents are invalid,  that the Company has not infringed
the patents, or both, and that the Company has not, as was alleged, breached the
Symbol license, nor underpaid royalties,  there can be no assurance that this or
any other action will be decided or settled in the Company's favor. There can be
no assurance  that others will not assert claims against the Company that result
in  litigation.  Any  such  litigation  could  result  in  significant  expense,
adversely impact the Company's marketing,  give rise to certain indemnity rights
on the part of customers and divert the Company's  attention from other matters.
If any of the Company's  products  were found to infringe a third-party  patent,
the third party could be entitled to injunctive relief,  which would prevent the
Company  from selling any such  infringing  products.  In addition,  the Company
could be required to pay monetary  damages.  Although  the Company  could seek a
license to sell products determined to infringe a third-party patent,  there can
be no assurance  that a license  would be available on terms  acceptable  to the
Company.  The Company could also attempt to redesign any infringing  products so
as to avoid infringement,


<PAGE>

although any effort to do so could be expensive and time consuming and there can
be no assurance the effort would be  successful.  See  "Business -  Intellectual
Property."

Competition.  The AIDC industry is highly  competitive with rapid  technological
change, product improvements, new product introduction and intellectual property
developments  representing key competitive factors. The Company also competes on
the basis of innovative design, high quality manufacturing,  technical expertise
in  scanning,  level of sales and support  services,  price and overall  product
functionality  and  fitness  for use.  Failure  to keep  pace with  product  and
technological   advances  could  negatively  affect  the  Company's  competitive
position and prospects for growth.  Several of the  Company's  competitors  have
substantially greater financial,  technical,  marketing and other resources than
the  Company.  As a result,  they may be able to respond  more quickly to new or
emerging  technologies  and to changes in  customer  requirements,  or to devote
greater resources to the development, promotion and sale of their products, than
can the Company.  In addition,  other larger  corporations  could enter the AIDC
industry.  Increased  competition  is likely to result in average  selling price
reductions,  reduced operating margins or loss of market share. No assurance can
be given that the Company will be able to compete  successfully  against current
and future competitors or that the competitive factors faced by the Company will
not adversely affect its business, financial condition or results of operations.
See "Business--Competition."

Product  Transitions.  The Company is dependent upon the introduction of new and
improved  products.  The Company's  financial  performance is dependent upon the
successful introduction of these products. The success will be dependent,  among
other things, upon the ability of the Company to complete development of certain
products,  customer  acceptance of and demand for these products and the ability
of the Company to  efficiently  manufacture  these products and to meet delivery
schedules. The introduction of new and enhanced products requires the Company to
manage the  transition  from older  products in order to minimize  disruption in
customer ordering  patterns,  avoid excess levels of older material  inventories
and ensure  that  adequate  supplies of new  product  can be  delivered  to meet
customer  demand.  There can be no assurance that the Company will  successfully
manage the transition to selling new products. The failure to do so could have a
material adverse effect on the Company's business and results of operations.

Dependence  on Sales by Third  Parties:  Significant  Customers.  A  significant
portion of the Company's  net sales are  dependent  upon the ability of its OEM,
value-added  reseller  (VAR),  distributor and systems  integrator  customers to
develop and sell products that  incorporate  the  Company's  scanning  products.
Factors, including economic conditions,  patent positions,  inventory positions,
the ability to sell the Company's products to end users, regulatory requirements
and other  marketing  restrictions  that adversely  affect the operations of the
Company's  OEM, VAR,  distributor  and systems  integrator  customers can have a
substantial impact upon the Company's  financial  results.  No assurances can be
given that the Company's OEM, VAR,  distributor and systems integrator customers
will not experience  financial or other difficulties that could adversely affect
their operations and, in turn, the results of operations of the Company.  During
1997 and 1996, no individual  customer accounted for more than 10% of net sales.
During 1995,  Telxon  Corporation  accounted for 17% of the Company's net sales.
See "Business--Sales and Marketing" and "--Customer Support and Services."

Risks  Associated  with  International   Operations.   The  Company's  sales  to
international  customers  increased from $19.3 million or 22% of total net sales
in 1995 to $95.2  million or 46% of net sales in 1997.  The  Company  intends to
continue  to expand its  operations  outside  of the United  States and to enter
additional  international  markets,  which will require  significant  management
attention and financial resources and which will result in a significant portion
of the  Company's net sales being  subject to the normal risks  associated  with
international  sales.  Such  risks  include  unexpected  changes  in  regulatory
requirements,  compliance  costs  associated  with  quality  control  standards,
special  standards  requirements,  longer  accounts  receivable  collections  in
certain geographic regions, tariffs and other barriers, difficulties in staffing
and  managing  international  subsidiary  operations,  potentially  adverse  tax
consequences, country-specific product requirements and political and regulatory
uncertainties.  There can be no  assurance  that these  factors will not have an
adverse   impact  on  the   Company's   ability  to  increase  or  maintain  its
international sales or results of operations. See "Management's

<PAGE>


Discussion and Analysis of Financial  Condition and Results of  Operations"  and
"Business--Sales and Marketing."

Exposure to Currency  Fluctuations.  Historically,  the  Company's  revenue from
international  operations  has  primarily  been  denominated  in  United  States
dollars.  During  1997,  approximately  50% of its  revenue  from  international
operations and 75% of its consolidated revenue were denominated in United States
dollars.  The Company expects that a growing  percentage of its business will be
conducted  in  currencies  other than the  United  States  dollar.  As a result,
fluctuations in the value of certain foreign  currencies could materially affect
the  Company's  business  operating  results and financial  condition.  Also, an
increase in the value of the United States dollar relative to foreign currencies
could  make  the  Company's  products  more  expensive  and,   therefore,   less
competitive  in  certain  markets.  Due  to  the  constantly  changing  currency
exposures  and the  volatility  of  currency  exchange  rates,  there  can be no
assurance  that the Company will not experience  currency  losses in the future,
nor can the Company predict the effect of exchange rate fluctuations upon future
operating  results.  The Company may  occasionally  enter into  forward  foreign
exchange contracts as a hedge against currency  fluctuations relating to foreign
sales denominated in foreign  currencies.  The forward contracts  generally have
maturities of  approximately 30 days and require the Company to exchange foreign
currencies  for United  States  dollars at  maturity,  at rates agreed to at the
inception of the  contracts.  Gains and losses on forward  contracts  are offset
against the foreign exchange gains and losses on the underlying hedged items and
are recorded in the Consolidated Statements of Operations.

Price. Traditionally, the selling price of the Company's products decreases over
the life of the product.  The Company endeavors to reduce manufacturing costs of
existing   products  and  to  introduce  new   products,   functions  and  other
price/performance-enhancing  features  in order to  mitigate  the effect of such
decreases. To the extent that such cost reductions, product enhancements and new
product  introductions  do not occur in a timely manner or do not achieve market
acceptance,  the  Company's  operating  results could be  materially,  adversely
affected.

Acquisitions.  The  Company  has in the  past  and  may  in the  future  acquire
businesses  or product  lines as a way of expanding  its product  offerings  and
acquiring new technology.  Failure of the Company to identify future acquisition
opportunities  and/or to integrate  effectively  businesses  that it may acquire
could have a material adverse effect on the Company's growth.

Dependence  on Key  Vendors.  The  Company's  ability  to  produce  and ship its
products on schedule is highly dependent on timely receipt of an adequate supply
of components and materials from its key vendors.  The Company  currently relies
on single suppliers, some of whom manufacture at a number of locations, for some
of the key  components  of its  products.  The Company  could incur  significant
set-up costs and experience  delays in  manufacturing  should it be necessary to
replace key vendors due to work stoppages,  shipping delays,  quality  problems,
financial  difficulties  or other factors.  There can be no assurance that these
potential  costs and  delays  would not have a  material  adverse  impact on the
Company's business or results of operations.  See  "Business--Manufacturing  and
Suppliers."

Fluctuations  in  Quarterly  Operating  Results.  Historically,  the Company has
experienced  variability  in its quarterly  results and the Company  anticipates
that such  variability  will  continue  in the future as a result of a number of
factors,  many of which are beyond the Company's control.  The factors affecting
this variability include demand for the Company's products,  the size and timing
of large customer  orders,  the entry of new competitors  and new  technological
advances  by  competitors,  changes  in  pricing  policies  by  the  Company  or
competitors, customer order deferrals in anticipation of product enhancements or
new product  offerings by the Company or its competitors,  changes in the mix of
products sold by the Company and general economic factors.

Since customers order products for delivery within 30 to 45 days, backlog is not
a reliable predictor of future results beyond the current quarter. The Company's
expense levels are based, in part, on expectations of future revenue. If revenue
levels are below expectations,  expense levels would be disproportionately  high
as a  percentage  of total  revenue and  operating  results  would be  adversely
affected.  The Company believes that quarterly  period-to-period  comparisons of
its financial  results are not  necessarily  meaningful and should not be relied
upon as an indication of future  performance.  See "Management's  Discussion and
Analysis of Financial Condition and Results of Operations."


<PAGE>

Government  Regulation.  The Company's  products and  operations  are subject to
regulation  by federal,  state and local  agencies in the United  States and its
products  are  subject to  regulation  in certain  foreign  countries  where the
Company's  products are sold.  While the Company  believes that its products and
operations comply with all applicable regulations,  there can be no assurance of
continued  compliance if these  regulations were to change.  Noncompliance  with
respect  to these  regulations  could  have a  material  adverse  impact  on the
Company's results of operations. See "Business--Government Regulation."

                               ITEM 2: PROPERTIES

     The Company's  principal  manufacturing,  engineering,  and  administrative
facility consists of an approximately 132,000 square foot Company-owned building
in Webster, New York, a suburb of Rochester, New York. This facility,  completed
in 1995, was  custom-designed to serve the Company's  operations and to permit a
relatively rapid 45,000 square foot manufacturing  addition. An adjacent 20 acre
parcel of land owned by the Company is also available for expansion. The Company
leases  approximately  28,000  square  feet of  offsite  storage  and shop space
immediately  adjacent to its principal  facility.  This lease expires January 2,
2000.

     The  Company  also  owns a 32 acre  site in  Eugene,  Oregon.  Engineering,
marketing  and  administrative  functions  are  contained  in a sixteen year old
54,000 square foot facility.  Manufacturing  and  warehousing are contained in a
separate eleven year old 56,000 square foot building.  In addition,  the Company
leases 9,000  square feet of offsite  storage and shop space  approximately  two
miles from the manufacturing facility. This lease expires June 30, 1998.

     Domestically,  the Company  maintains  offices under short-term  leases for
individual sales and support personnel in or near Dallas,  Texas;  Dayton, Ohio;
Raleigh, North Carolina;  Denver, Colorado; Miami, Florida and Skaneateles,  New
York in order to serve North, Central and South America.

     Internationally,  the Company maintains offices in or near Tokyo,  Beijing,
Sydney, Hong Kong, London, Paris, Milan, Frankfurt, Brussels, Madrid, Malmo, and
Ontario.  These offices house from one to 20 people in 300 to 10,000 square foot
facilities under short-term leases.

     All  of the  Company's  locations  are in  good  condition  and  management
believes  that  the  Company  has  sufficient  manufacturing  capacity  for  the
foreseeable future.

                            ITEM 3: LEGAL PROCEEDINGS

     There is  litigation  pending in the United States  District  court for the
Western District of New York located in Rochester,  New York between the Company
and one of its  customers,  Data  General,  on the one hand,  and  Symbol on the
other,  involving certain of Symbol's patents.  In that action,  the Company has
also alleged  violations of the antitrust  laws and unfair  practices by Symbol.
Symbol  has  alleged  patent   infringement  and  breaches  of  certain  license
agreements between the Company and Symbol,  including claims that royalties have
been  underpaid.  The Company has assumed the  responsibility  of defending  the
action on behalf of Data General.

     The  litigation  is in the early stages of  discovery.  The Court had set a
hearing  in  July,  1997  which  was  to  have  been  solely  related  to  claim
construction  of the  patent  claims  alleged  by Symbol to be  infringed.  That
hearing was taken off the Court's calendar.  More recently,  a status conference
was held on February 19, 1998 at which time the parties and the Court  discussed
the status of the suit and, in particular, whether the patent or contract issues
would be heard first.  The parties have since  proposed a schedule to the Court,
seeking a trial of the contract issues in late fall 1998.

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

     There were no matters  submitted to a vote of security  holders  during the
fourth quarter of the period ended December 31, 1997.


<PAGE>


<TABLE>
                        EXECUTIVE OFFICERS OF REGISTRANT

The  Company's  executive officers as of December 31, 1997, were as follows.
<CAPTION>
Name                      Age    Officer/Position
----                      ---    ----------------
<S>                       <C>   <C>
Robert C. Strandberg ..   40. ..President and Chief Executive Officer

Edward J. Biernat .....   43....Vice President, Quality

Charles E. Biss .......   45....Vice President, Verification

Cecil F. Bowes ........   55....Vice President, Sales - The Americas, Asia Pacific

Nigel P. Davis ........   47....Vice President, Sales - Europe, Middle East, Africa

Scott D. Deverell .....   32....Assistant Treasurer

G. William Hartman ....   52....Vice President, Automation

Dennis T. Hopwood .....   48....Vice President, Human Resources

William L. Parnell, Jr    41....Vice President, Operations

Brad R. Reddersen .....   45....Vice President, Chief Technology Officer

Matt D. Schler ........   42....Vice President, Engineering and Product Development

Michael J. Stachura ...   42....Vice President, Finance

Roger D. Tedford ......   44....Vice President, Chief Information Officer

William J. Woodard ....   46....Vice President, Chief Financial Officer and Treasurer
</TABLE>



<PAGE>



     Robert C. Strandberg has served as President and Chief Executive Officer of
the Company since April 1997 and was Executive Vice President from November 1996
until April 1997. Prior to joining the Company,  Mr.  Strandberg was Chairman of
the  Board of  Directors,  President  and Chief  Executive  Officer  of  Datamax
International  Corporation  ("Datamax"),  Orlando,  Florida,  from 1991 to 1996.
Datamax designs and manufactures thermal bar code printers. Mr. Strandberg holds
a B.S. in Industrial Engineering Operations Research from Cornell University and
an M.B.A. from Harvard University.

     Edward J.  Biernat has served as Vice  President,  Quality,  since  January
1996.  Prior to joining  the  Company,  Mr.  Biernat  was the manager of Quality
Systems for Thin Film  Technology,  a division of Bausch and Lomb, Inc. based in
Rochester,  New York  (1989-1996).  Mr. Biernat holds B.S. degrees in Electrical
and Mechanical Engineering from Clarkson University.

     Charles E. Biss has served as Vice President,  Verification  Products since
January 1996,  as General  Manager,  Verification  Products  (1995-1996)  and as
Product  and  technical  Support  Manager  (1985-1995).  Mr. Biss has served the
Company in a variety of technical and  production  related roles since 1973. Mr.
Biss represents the Company on a number of National and International  standards
creating committees  relating to bar codes and the automatic  identification and
data capture industry.  Mr. Biss holds a B.S. degree in Photographic Science and
Engineering from Rochester Institute of Technology.

     Cecil F. Bowes has served as Vice  President,  Sales - The  Americas,  Asia
Pacific since December 1996. Prior thereto, he was Group Director, North America
for Spectra  from  November  1990 until  December  1996.  Mr. Bowes holds a B.S.
degree in Education from the University of Dayton.

     Nigel P. Davis has served as Vice President,  Sales - Europe,  Middle East,
Africa (EMEA) since July 1996. Prior thereto,  he was Group Director for Spectra
- EMEA from March 1993 to May 1996.

     Scott D. Deverell has served as Assistant  Treasurer  since  September 1997
and was Controller  from 1990 until September  1997. Mr.  Deverell,  a certified
public  accountant,  received a B.S. in  Accounting  from SUNY at Geneseo and an
M.B.A. from Rochester Institute of Technology.

     G. William Hartman has served as Vice President, Automation since September
1997.  Prior to joining  the  Company,  he was Senior Vice  President  and Chief
Operating  Officer of Datamax  from 1991 to 1996.  Mr.  Hartman  holds a B.S. in
Mechanical  Engineering  from the  University  of Utah and an M.S. in Mechanical
Engineering from Villanova University.

     Dennis T. Hopwood has served as Vice President,  Human Resources since July
1997. Prior thereto, he was Vice President, Human Resources for Spectra from May
1985 to January 1997.  Mr. Hopwood holds a B.S. in Sociology from the University
of Idaho and an M.S. in higher education  administration  from the University of
Wisconsin.

     William L.  Parnell,  Jr. has served as Vice  President,  Operations  since
October 1996. Prior thereto,  he was Vice President - Operations of Spectra from
November 1990 until October 1996.  Mr.  Parnell  received a B.S. in Physics from
Utah State University and an M.B.A. from the University of Washington.

     Brad R. Reddersen has served as Vice President,  Chief  Technology  Officer
since December 1997, as Vice President, Engineering and Product Development from
April 1997 to November 1997 and as Vice President of New Products from July 1996
to March 1997.  Prior thereto,  he was Vice  President,  New Products of Spectra
from June 1993 until July 1996. Mr. Reddersen  received a B.S. in Physics and an
M.S. in Optical Engineering from the University of Rochester.

<PAGE>

     Matt D.  Schler  has  served as Vice  President,  Engineering  and  Product
Development  since  November  1997.  Prior  thereto,  he was Vice  President  of
Engineering at Percon Inc.,  Eugene,  Oregon, a manufacturer of bar code reading
products,  from  February  1997 to  November  1997  and  Vice  President  of New
Products, Engineering Manager of Spectra from March 1992 until January 1997. Mr.
Schler received a B.S. degree in Electrical  Engineering  from the University of
Colorado.

     Michael J. Stachura has served as Vice  President,  Finance since September
1997.  Prior thereto,  he was Vice President,  Corporate  Controller of Genencor
International,  Inc.  from  January  1991 until August  1997.  Mr.  Stachura,  a
certified public accountant, received a B.S. in Accounting from Canisius College
in Buffalo.

     Roger D. Tedford has served as Vice President,  Chief  Information  Officer
since  November  1996.  Prior  thereto,  he was Vice  President,  Treasurer  and
Secretary  of Spectra  from  November  1990 until  November  1996.  Mr.  Tedford
received a B.A. in  Accounting/Finance  and an M.B.A. from California University
at Fullerton.

     William J. Woodard has served as Vice President,  Chief  Financial  Officer
and Treasurer  since October 1996.  Prior to that, he served as Vice  President,
Finance and Treasurer from August 1994 until  September  1996.  Prior to joining
the  Company,  he was Vice  President  and  Chief  Financial  Officer,  Champion
Products  (1987-1994).  Mr. Woodard, a certified public  accountant,  received a
B.B.A. degree in Accounting from St. Bonaventure University.



<PAGE>




                                     PART II

       ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SECURITY
                                 HOLDER MATTERS

a) Market  Information:  The  Company's  common  shares are traded on The Nasdaq
Stock MarketSM under the symbol PSCX.  The following  table sets forth,  for the
periods indicated, the high and low sale prices for the Common Shares.

                                              High                Low
1997
    Fourth Quarter.......................     $13.50             $9.06
    Third Quarter........................     $10.13             $6.63
    Second Quarter.......................     $ 7.88             $6.13
    First Quarter........................     $ 9.00             $6.88

1996
    Fourth Quarter.......................     $ 9.63             $6.88
    Third Quarter........................     $10.00             $7.00
    Second Quarter.......................     $13.50             $7.13
    First Quarter........................     $ 9.75             $7.63


b) Holders:  As of December 31, 1997, there were approximately  1,600 holders of
record of common shares.

c) Dividends:  The Company has not paid any cash  dividends  since 1979 and does
not anticipate  paying cash dividends in the foreseeable  future.  The Company's
senior debt and subordinated term loan agreements restrict payment of dividends

<PAGE>


                         ITEM 6: SELECTED FINANCIAL DATA

                (All amounts in thousands, except per share data)

         The selected  consolidated  financial data presented  below for each of
the five years in the period ended  December 31, 1997 have been derived from the
Company's consolidated financial statements,  which statements have been audited
by Arthur Andersen LLP,  independent public  accountants,  as indicated in their
reports  thereon.  The selected  consolidated  financial  data should be read in
conjunction  with  the  Consolidated  Financial  Statements  and  Notes  thereto
included elsewhere in this report.

 <TABLE>
<CAPTION>

                                                                            Year Ended December 31,
                                                  ----------------------------------------------------------------------------
                                                     1997            1996            1995           1994            1993
                                                     ----            ----            ----     -     ----            ----
<S>                                                  <C>             <C>              <C>            <C>             <C>
Statement of Operations Data:
     Net sales ..................................    $207,840        $146,051         $87,516        $60,447         $38,894
     Cost of sales ..............................     122,995 (1)      83,675          50,634         32,198          20,256
                                                  ---------------------------------------------------------------------------
        Gross profit ............................      84,845          62,376          36,882         28,249          18,638

     Operating expenses:
        Engineering, research and development....      13,018          11,069           4,962          3,810           3,754
        Selling, general and administrative .....      44,154          37,855          23,024         16,031          11,826
        Write-off of intangible assets ..........         --              --              --             --             167
        Acquisition related restructuring and
          other costs ...........................          --          70,068 (2)          --          6,894 (3)          --
        Severance and other costs ...............       4,191 (1)          --              --             --              --
        Amortization of intangibles from
           business acquisitions ................       6,715           3,564             877            485             220
                                                  ---------------------------------------------------------------------------
     Income/(loss) from operations ..............      16,767        (60,180)           8,019          1,029           2,671
     Interest and other income/expense ..........     (12,016)        (5,747)             676            110              45
                                                  ---------------------------------------------------------------------------
     Income/(loss) from continuing operations
          before income tax provision/(benefit)..       4,751 (1)    (65,927) (2)       8,695          1,139 (3)       2,716
     Income tax provision/(benefit) .............       1,761        (24,393)           3,246            527             865
                                                  ---------------------------------------------------------------------------
     Income/(loss) from continuing operations....       2,990        (41,534)           5,449            612           1,851
      Loss from discontinued operations .........       (101)         (5,446)              --             --              --
                                                  ---------------------------------------------------------------------------
       Net income/(loss) ........................   $  2,889 (1)   $(46,980) (2)     $ 5,449        $   612 (3)     $ 1,851
                                                  ===========================================================================
      Net income/(loss) per common and common equivalent share:
       Basic:
         Continuing operations ..................       $0.27         $(3.96)           $0.58          $0.08           $0.26
         Discontinued operations ................      (0.01)          (0.52)              --             --              --
                                                  ===========================================================================
         Net income/(loss) ......................       $0.26 (1)     $(4.48) (2)       $0.58          $0.08 (3)       $0.26
                                                  ===========================================================================
       Diluted:
         Continuing operations ..................       $0.25         $(3.96)           $0.54          $0.08           $0.25
         Discontinued operations ................      (0.01)          (0.52)              --             --              --
                                                  ===========================================================================
         Net income/(loss) ......................       $0.24 (1)     $(4.48) (2)       $0.54          $0.08 (3)       $0.25
                                                  ===========================================================================
      Weighted average number of common and
         common equivalent shares outstanding:
         Basic .................................       11,197          10,490           9,329          7,319           7,202
         Diluted ...............................       11,843          10,490          10,013          7,617           7,476
</TABLE>

(1) Severance  and other costs  reduced 1997 income  before  income  taxes,  net
income,  basic EPS and  diluted EPS by $5.2  million,  $3.3  million,  $0.29 and
$0.28,  respectively.
(2) The acquisition  related  restructuring  and other costs reduced 1996 income
before income  taxes,  net income,  basic EPS and diluted EPS by $70.1  million,
$44.2 million, $4.21 and $4.21, respectively.
(3) The acquisition  related  restructuring  and other costs reduced 1994 income
before income taxes, net income, basic EPS and diluted EPS by $6.9 million, $4.5
million, $0.61 and $0.59, respectively.

<PAGE>
<TABLE>
<CAPTION>
                                                             Year Ended December 31,
                                                ---------------------------------------------
                                                1997       1996       1995     1994      1993
                                                ----       ----       ----     ----      ----
<S>                                             <C>       <C>        <C>      <C>       <C>
Balance Sheet Data:
  Cash and cash equivalents ..................  $2,271    $10,838    $5,538   $2,720    $9,120
  Working capital ............................  12,112     13,320    20,397    8,014    11,779
  Total assets ............................... 172,798    183,361    71,237   52,763    32,063
  Long-term debt, including current maturities 108,554    127,453       623   13,609     1,806
  Total shareholders' equity .................  29,330     15,301    53,327   22,233    21,265

</TABLE>
            ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

         The  following  discussion  should  be read  in  conjunction  with  the
Consolidated  Financial  Statements and the Notes thereto appearing elsewhere in
this report.

Results of Operations

         The  following  table  sets  forth,  for the years  indicated,  certain
consolidated financial data expressed as a percentage of net sales:
<TABLE>
<CAPTION>
                                                                       Year Ended December 31,
                                               -------------------------------------------------------------------------
                                                        1997                     1996                     1995
                                               -----------------------  -----------------------   ----------------------
                                                                        (dollars in thousands)
<S>                                              <C>           <C>        <C>           <C>         <C>          <C>
 Net sales .................................     $207,840      100.0%     $146,051      100.0%      $87,516      100.0%
 Cost of sales .............................      122,995 (1)    59.2       83,675        57.3       50,634        57.9
                                               -----------   ---------  -----------    --------   ----------  ----------
   Gross profit ............................       84,845        40.8       62,376        42.7       36,882        42.1
 Operating expenses:
   Engineering, research and development ...       13,018         6.3       11,069         7.6        4,962         5.7
   Selling, general and administrative .....       44,154        21.2       37,855        25.9       23,024        26.3
   Severance and other costs ...............        4,191 (1)     2.0           --          --           --          --
   Acquisition related restructuring and
     other costs ...........................           --          --       70,068 (2)    48.0           --          --
   Amortization of intangibles from business
      acquisitions .........................        6,715         3.2        3,564         2.4          877         1.0
                                               -----------   ---------  -----------    --------   ----------  ----------
 Income/(loss)  from operations ............       16,767         8.1     (60,180)      (41.2)        8,019         9.1
 Interest and other income/(expense) .......      (12,016)       (5.8)      (5,747)       (3.9)          676         0.8
                                               -----------   ---------  -----------    --------   ----------  ----------
 Income/(loss) from continuing operations
 before income tax provision/(benefit)......        4,751 (1)     2.3     (65,927) (2)  (45.1)        8,695         9.9
 Income tax provision/(benefit) ............        1,761         0.9     (24,393)      (16.7)        3,246         3.7
                                               -----------   ---------  -----------    --------   ----------  ----------
 Income/(loss) from continuing operations ..        2,990         1.4     (41,534)      (28.4)        5,449         6.2
 Loss from discontinued operations .........        (101)          --      (5,446)       (3.7)           --          --
                                               ===========   =========  ===========    ========   ==========  ==========
 Net income/(loss) .........................    $   2,889 (1)    1.4%   $ (46,980) (2) (32.1%)       $5,449        6.2%
                                               ===========   =========  ===========    ========   ==========  ==========
</TABLE>


(1)   Severance  and other costs  reduced 1997 income before income taxes and
      net income by $5.2 million and $3.3 million, respectively.
(2)   The  acquisition  related  restructuring  and other costs  reduced 1996
      income  before  income taxes and net income by $70.1  million and $44.2
      million, respectively.
<PAGE>

Overview


Nineteen  ninety-seven  was the first  full year in which the  Company  included
Spectra in its  consolidated  financial  results.  The Spectra  acquisition  was
accounted  for as a purchase  and is included in the 1996  financial  statements
since July 12, 1996, the acquisition date.

During the second half of 1997, the Company's focus was on improving operational
results. In the second half of 1997, income from continuing  operations improved
327% versus the first half of 1997.  In the fourth  quarter,  the  Company's net
income of $2.8 million was a record quarterly performance. The Company completed
a private equity  placement  with net proceeds of $10.2 million and  implemented
certain actions which are expected to reduce  annualized  operating  expenses by
$6.0  million.  The Company  expects that 1998 results will further  reflect the
benefits of these initiatives.

For the Year Ended December 31, 1997

Net sales of $207.8  million for the year ended  December 31, 1997 increased 42%
versus  1996.  The increase in net sales is  primarily  due to the  inclusion of
Spectra  product  sales for the full  year in 1997 and  increased  sales  volume
offset by lower average  selling prices.  International  net sales increased 73%
over the prior year primarily due to the Spectra acquisition and represented 46%
of sales versus 38% in 1996.

Gross profit of $84.8 million for the year ended December 31, 1997 increased 36%
versus 1996. As a percentage  of sales,  gross profit was 40.8% in 1997 compared
to 42.7% in 1996.  The increase in gross profit  dollars is primarily due to the
inclusion of Spectra for the full year,  while the decrease in gross profit as a
percentage  of sales is  primarily  due to a change in the mix of  products  and
lower selling  prices for handheld and fixed position  scanner  products and the
$1.0  million  inventory  write-off  recorded  in the  second  quarter  for  the
discontinuation of certain products to streamline the Company's product lines.

Engineering,  research and development  (ER&D) expenses of $13.0 million for the
year ended  December 31, 1997  increased  $1.9 million or 18% versus 1996.  As a
percentage of sales,  ER&D was 6.3% versus 7.6% in 1996. The dollar  increase in
1997 was primarily due to the inclusion of Spectra for the full year in 1997. As
a result of efficiencies  developed due to the integration of Spectra, ER&D as a
percentage of sales declined in 1997.

Selling,  general and  administrative  (SG&A)  expenses of $44.2 million for the
year ended  December 31, 1997  increased $6.3 million or 16.6% versus 1996. As a
percentage of sales, SG&A declined to 21.2% in 1997 from 25.9% in 1996. The 1997
dollar  increase is due to the  inclusion  of Spectra for the full year in 1997.
The  decrease  in SG&A as a  percentage  of sales is a  result  of  efficiencies
developed due to the  integration  of Spectra.  In addition,  the Company is now
operating under the  Spectra-Symbol  License Agreement which resulted in a lower
royalty expense.

During the second quarter of 1997, the Company recorded a one-time pretax charge
of  $4.2  million  for  severance   and  other  costs.   Of  the  total  charge,
approximately $2.3 million was associated with the Severance  Agreement with the
former CEO,  $1.2 million was for employee  severance  and benefit costs for the
elimination of approximately 30 positions  including several senior  executives,
and $0.7 million was for the  centralization  of the  research  and  development
efforts and relocation of manufacturing of certain product lines between its two
manufacturing  facilities.  Accrued expenses for these activities as of December
31,  1997 was  approximately  $2.9  million,  of which $1.1  million  related to
long-term  contractual  obligations.  These  costs and the  inventory  write-off
reduced 1997 income before income taxes,  net income,  basic EPS and diluted EPS
by $5.2 million, $3.3 million, $0.29 and $0.28, respectively.


<PAGE>

The Company's effective tax rate was 37.1% in 1997 versus 37.0% in 1996.

For the Year Ended December 31, 1996

Net sales of $146.1 million for the year ended December 31, 1996 increased $58.5
million or 67% versus 1995.  The increase in net sales was due to the  inclusion
of Spectra  product  sales  offset,  in part,  by the lower sales volumes of the
Company's  scan engine  products.  International  sales  increased  185% in 1996
primarily due to the Spectra acquisition and represented 38% of sales versus 22%
in 1995.

Gross profit of $62.4 million for the year ended December 31, 1996 increased 69%
versus 1995.  As a percentage  of sales,  gross profit was 42.7% in 1996 up from
42.1% in 1995.  The increase in gross profit dollars and percentage of sales was
primarily due to the inclusion of Spectra.

ER&D  expenses of $11.1 million for the year ended  December 31, 1996  increased
$6.1 million or 123% versus 1995.  As a percentage  of sales,  ER&D was 7.6%, an
increase  from 5.7% in 1995.  The 1996 dollar  increase was primarily due to the
inclusion of Spectra, as well as increased expenses related to the Company's new
product  development  activities  for its  handheld and fixed  position  scanner
products.

SG&A  expenses of $37.9 million for the year ended  December 31, 1996  increased
$14.8  million or 64% versus 1995.  As a percentage  of sales,  SG&A declined to
25.9% in 1996 from 26.3% in 1995. The 1996 dollar increase was primarily related
to the inclusion of Spectra,  start-up costs  associated  with the Company's new
subsidiary  responsible  for sales and support in South and Central  America and
increased patent related expenses.

During the third quarter of 1996, the Company recorded a one-time, pretax charge
of $10.0 million for the costs of  restructuring  its existing  operations  with
those of Spectra  which was  acquired in July 1996.  Of the total  restructuring
charge,  approximately  $5.0  million  was  associated  with the  closing of the
Company's Sanford,  Florida manufacturing  facility, $3.6 million was related to
the write-off of previously  existing  intangible  and tangible  assets and $1.4
million  was  recorded  for  employee   severance  and  benefit  costs  for  the
elimination of seven positions.  As of December 31, 1997, all positions targeted
in the restructuring program have been eliminated.  Restructuring activities are
expected to be  substantially  complete by the end of the first quarter of 1998.
The  restructuring  accrual  as of  December  31,  1997 was  approximately  $1.0
million.

In addition,  in the third quarter of 1996, the Company  allocated $60.1 million
of the Spectra  purchase price to acquired  in-process  research and development
projects,  which  represents the estimated fair values related to these projects
determined  by  an  independent  appraisal.   Proven  valuation  procedures  and
techniques were utilized in determining the fair market value of each intangible
asset. The development  technologies were evaluated to determine that there were
no alternative  future uses. Such  evaluation  consisted of a specific review of
the efforts,  including the overall  objectives of the project,  progress toward
the objectives and uniqueness of the developments  toward these  objectives.  To
bring these  projects to  fruition,  high risk  developmental  issues need to be
resolved  which  will  require   substantial   additional  effort  and  testing.
Therefore,  technological  feasibility  of these new  products  has not yet been
achieved.  As these  projects  had not  reached  technological  feasibility  and
alternative  future  use of these  developmental  technologies,  apart  from the
objectives of the individual  projects did not exist,  these costs were expensed
as of the acquisition  date. The  acquisition  related  restructuring  and other
costs reduced 1996 income before income taxes, net income, basic EPS and diluted
EPS by $70.1 million, $44.2 million, $4.21 and $4.21, respectively.


<PAGE>


The  Company's  effective  tax rate was 37.0% in 1996 versus  37.3% in 1995.  In
1996,  the Company  recognized a $24.4 million income tax benefit as a result of
the acquisition related restructuring and other costs discussed above.

Discontinued Operations

During the third quarter of 1996,  the Company  adopted a plan to dispose of its
TxCOM  subsidiary.  TxCOM was  acquired  as a part of the  Spectra  acquisition.
Results from  operations of TxCOM were a gain of $0.2 million in 1997 and a loss
of $0.2  million  in 1996.  Disposal  of TxCOM,  which  occurred  in June  1997,
resulted in the recording of losses of $ 0.3 million in 1997 and $5.2 million in
1996.  These losses include the write-down of the assets to their net realizable
value  and the costs of  disposing  of the  subsidiary,  net of  applicable  tax
benefits.

Liquidity and Capital Resources

Current  assets  declined $3.2 million from  December 31, 1996  primarily due to
decreased cash balances which were utilized to reduce the outstanding balance of
the revolving credit facility, offset by increased levels of accounts receivable
from increased sales in Europe where customers have longer credit terms. Current
liabilities  declined  $2.0 million  from  December  31, 1996  primarily  due to
reduced accrued expenses and acquisition related  restructuring costs, offset by
an increase in the  current  portion of  long-term  debt.  As a result,  working
capital decreased $ 1.2 million in 1997.

In 1996,  current  assets  increased  $23.2  million  primarily due to increased
accounts  receivable  and inventory  levels due to the  acquisition  of Spectra.
Current  liabilities  increased  $30.3 million in 1996  primarily due to accrued
acquisition costs, restructuring costs and increased accounts payable to support
higher operating  levels.  As a result,  working capital  decreased $7.1 million
from 1995 to 1996.

Property plant and equipment  expenditures totaled $6.6 million in 1997 and $4.8
million in 1996. The 1997  expenditures  primarily  related to manufacturing and
research  equipment and new product  tooling.  The 1996  expenditures  primarily
related to manufacturing equipment and new product tooling.

In  September  1997,  the Company  completed a private  placement of equity with
Hydra  Investissements  S.A.,  a Luxembourg  Corporation  (the  Purchaser).  The
Company  issued and sold 110 thousand  shares of Series A Convertible  Preferred
Shares (the Preferred  Shares) which are  convertible  into 1.375 million Common
Shares.  In  connection  with the issuance of the  Preferred  Shares,  a warrant
evidencing  the right to purchase an aggregate of 180 thousand  Common Shares of
the Company was issued to the  Purchaser.  This warrant has an exercise price of
$8.00 per share and may be exercised before September 10, 2001. As a result, the
Purchaser is the beneficial owner of 1.555 million Common Shares of the Company.
The net  proceeds to the  Company  from the  offering  were $10.2  million.  The
Company used the proceeds for working capital purposes and to repay a portion of
its senior revolving credit facility.

The long-term  debt-to-capital  percentage was 76.6% at December 31, 1997 versus
88.5% at  December  31,1996  primarily  due to the private  placement  described
above.  At December 31,  1997,  liquidity  immediately  available to the Company
consisted  of cash and cash  equivalents  of  approximately  $2.3  million.  The
Company's credit  facilities  consist of senior term loans of $ 71.0 million,  a
senior revolving  credit facility of $20.0 million and a subordinated  term loan
of  $30.0  million.   The  Company  has  $104.0  million  outstanding  on  these
facilities.  The Company  believes that its cash resources and available  credit
facilities,  in addition to its operating cash flows, are sufficient to meet its
requirements for the next twelve months.

In the opinion of  management,  inflation  has not had a material  effect on the
operations of the Company.
<PAGE>


The Company  generates a portion of its sales from customers in the Asia Pacific
region. Less than 5% of consolidated accounts receivable as of December 31, 1997
were generated from these customers.  All accounts are remitted in U.S. dollars.
The Company believes it has appropriate  reserves such that the current economic
crisis and  continued  volatility  in  exchange  rates in this  region  will not
materially affect results of operations of the Company.

The Company has evaluated its information  technology  infrastructure  to ensure
that computer  systems and software will recognize and process the year 2000 and
beyond  with no  significant  effect on  customers  or  disruptions  to business
operations.  The Company does not expect the cost of modifying  its  information
technology  infrastructure  for  Year  2000  compliance  to be  material  to its
financial  condition or results of  operations.  The Company does not anticipate
any  material  disruption  in its  operations  as a result of any failure by the
Company to be in compliance.


               ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     This item is submitted as a separate  section of this report.  See Exhibits
in Part IV.
              ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
                     ON ACCOUNTING AND FINANCIAL DISCLOSURE

         There have been no disagreements on accounting and financial disclosure
matters.

                                    PART III

           ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The  information  required  by this item is  presented  under  the  caption
entitled "Election of Directors - Information  Concerning Nominees for Directors
and  Other  Incumbent  Members  of the  Board  of  Directors"  contained  in the
definitive  proxy  statement  issued in  connection  with the Annual  Meeting of
Shareholders  to be held  May 7,  1998 and is  incorporated  in this  report  by
reference  thereto.   The  information   regarding  Executive  Officers  of  the
Registrant is found in Part I of this report.

                         ITEM 11: EXECUTIVE COMPENSATION

     The  information  required  by this item is  presented  under  the  caption
entitled  "Executive  Officer  Compensation"  contained in the definitive  proxy
statement  issued in connection  with the Annual Meeting of  Shareholders  to be
held May 7,  1998 and is  incorporated  in this  report  by  reference  thereto,
except,  however,  the sections entitled  "Performance Graph" and the "Report of
the  Compensation  Committee of the Board of Directors" are not  incorporated in
this report by reference.

     ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The  information  required  by this item is  presented  under  the  caption
entitled  "Security  Ownership  of Certain  Beneficial  Owners  and  Management"
contained in the definitive proxy statement issued in connection with the Annual
Meeting  of  Shareholders  to be held May 7,  1998 and is  incorporated  in this
report by reference thereto.


             ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The  information  required  by this item is  presented  under  the  caption
"Executive  Officer  Compensation  - Interest of  Directors  and  Management  in
Certain  Transactions"  contained in the definitive  proxy  statement  issued in
connection with the Annual Meeting of Shareholders to be held May 7, 1998 and is
incorporated in this report by reference thereto.


<PAGE>


                                     PART IV

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

     (a) 1        Financial Statements                                Page

                  Report of Independent Public Accountants...............34

                  Consolidated Financial Statements......................35

                  Notes to Consolidated Financial Statements.............39

     (a) 2        Financial Statement Schedules:

                  Included in Part IV of this report:

                  Schedule II    Valuation and Qualifying Accounts.......58

         Other schedules are omitted because of the absence of conditions  under
     which they are required or because the required information is given in the
     consolidated financial statements or notes thereto.

     (a) 3        Exhibits:

2.1  Stock Purchase  Agreement  among BTR Dunlop Inc.,  Electro  Corporation and
     LazerData Holdings, Inc. dated December 21, 1994 (incorporated by reference
     to Exhibit 2.1 of the Company's  Current  Report on Form 8-K dated December
     21, 1994).

2.2  Asset and Stock Purchase  Agreement among PSC Inc.,  Spectra-Physics,  Inc.
     and Spectra-Physics Holdings, S.A. dated May 20, 1996, as amended by letter
     dated July 12,  1996  (incorporated  by  reference  to  Exhibit  2.1 of the
     Company's Current Report on Form 8-K dated July 29, 1996 (the "1996 8-K")).

3.1  Restated Certificate of Incorporation of the Company and amendments thereto
     (incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report
     on Form 10-Q for the Quarter ended June 30, 1996).

3.2  Certificate of Amendment of Certificate of  Incorporation of PSC Inc. filed
     with the  Secretary  of State of the State of New York on September 5, 1997
     (incorporated  by reference to Exhibit 3.1 of the Company's  Current Report
     on Form 8-K dated as of September 10, 1997 (the "1997 Form 8-K")).

3.3  Certificate of Amendment of Certificate of  Incorporation of PSC Inc. filed
     with the  Secretary  of State of the State of New York on December 30, 1997
     .........................................................................59

3.4  Bylaws of the Company as currently in effect  (incorporated by reference to
     Exhibit 3.1 of the Company's  Quarterly Report on Form 10-Q for the quarter
     ended September 30, 1994).

4.1  Form of  Certificate  for Common  Shares of the  Company  (incorporated  by
     reference to Exhibit 4.3 of the  Company's  Registration  Statement on Form
     S-3, effective March 24, 1995 (No. 33-89178)).

4.2  Form of the 11.25% Senior Subordinated Note of SpectraScan,  Inc., due June
     30, 2006 (Notes were issued to seven Purchasers in the aggregate  principal
     amount of  $30,000,000)  (incorporated  by  reference to Exhibit 4.1 of the
     1996 8-K).

4.3  Form of Note Guarantee dated July 12, 1996 made by PSC Inc. and each of the
     domestic  subsidiaries  of PSC Inc. to each of the purchasers of the Senior
     Subordinated  Notes  (incorporated  by reference to Exhibit 4.2 of the 1996
     8-K).
<PAGE>

4.4  Form of Warrant issued to the Purchasers  named in the Securities  Purchase
     Agreements  dated July 12, 1996 (Warrants  were issued to seven  Purchasers
     for an aggregate of 975,000 common shares of the Company)  (incorporated by
     reference to Exhibit 4.3 of the 1996 8-K).

4.5  Subordinated Installment Promissory Note of PSC Acquisition, Inc. issued to
     Spectra-Physics,  Inc.  on  July  12,  1996  in  the  principal  amount  of
     $5,000,000 (incorporated by reference to Exhibit 4.4 of the 1996 8-K).

4.6  Note  Guarantee  dated July 12, 1996 made by PSC Inc.  to  Spectra-Physics,
     Inc. (incorporated by reference to Exhibit 4.5 of the 1996 8-K).

4.7  Form of  Certificate  for Preferred  Stock issued to Hydra  Investissements
     S.A. on September 10, 1997 (incorporated by reference to Exhibit 4.1 of the
     1997 Form 8-K).

4.8  Form of Warrant issued to Hydra  Investissements S.A. on September 10, 1997
     (incorporated by reference to Exhibit 4.2 of the 1997 Form 8-K).

4.9  Form of Rights Agreement dated as of December 30, 1997 between PSC Inc. and
     ChaseMellon  Shareholder Services,  L.L.C., as Rights Agent, which includes
     as Exhibit A - Form of Right Certificate;  Exhibit B - Summary of Rights to
     Purchase  Preferred Stock; and Exhibit C - Form of Certificate of Amendment
     designating the relative rights,  preferences and limitations of the Series
     B  Preferred  Shares  (incorporated  by  reference  to  Exhibit  4.1 of the
     Company's Current Report on Form 8-K dated December 30, 1997).

10.1*Severance  Agreement  between the Company and L. Michael Hone,  dated April
     30,  1997  (incorporated  by  reference  to Exhibit  10.1 of the  Company's
     Quarterly Report on Form 10-Q for the quarter ended April 4, 1997).

10.2*Agreement  between  the  Company  and Robert S.  Ehrlich as of June 2, 1997
     (incorporated  by  reference  to Exhibit  10.2 of the  Company's  Quarterly
     Report on Form 10-Q for the  quarter  ended July 4, 1997 (the "July 4, 1997
     Form 10-Q")).

10.3*Form of  Change-in-Control/Severance  Agreement  between  the  Company  and
     certain of its  executive  officers  (incorporated  by reference to Exhibit
     10.3 of the Company's  Annual Report on Form 10-K for the fiscal year ended
     December 31, 1996 (the "December 31,1996 Form 10-K")).

10.4*Form of third  party  severance  letter  between  Spectra-Physics  Scanning
     Systems, Inc. and certain executive officers  (incorporated by reference to
     Exhibit 10.4 of the December 31, 1996 Form 10-K).

10.5*Employment  Agreement  between the Company and Robert C. Strandberg,  as of
     June 2, 1997 (incorporated by reference to Exhibit 10.1 of the July 4, 1997
     Form 10-Q).

10.6*Severance and Consulting  Agreement  between the Company and Jay M. Eastman
     dated as of July 15, 1997................................................64

10.7*Form of Indemnification Agreement between the Company and its Directors and
     Officers  (incorporated  by  reference  to Exhibit  10.10 to the  Company's
     Annual Report on Form 10-K for the fiscal year ended December 31, 1991).

10.8*Plan  for  Deferral  of   Directors'   Fees  dated  as  of  March  4,  1992
     (incorporated  by  reference  to Exhibit  10.2 of the  Company's  Quarterly
     Report on Form 10-Q for the quarter ended June 30, 1992).

10.9*Amended and Restated 1987 Stock Option Plan  (incorporated  by reference to
     Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter
     ended June 30, 1994).

<PAGE>

10.10* 1994 Stock Option Plan  (incorporated  by reference to Exhibit 4.1 of the
     Company's  Registration  Statement  on Form S-8  dated  June  20,  1995 No.
     33-60389).

10.11* 1995 Employee Stock Purchase Plan  (incorporated  by reference to Exhibit
     4.1 of the Company's Registration Statement on Form S-8 dated June 19, 1995
     No. 33-60343).

10.12* 1997 Management Incentive Plan.........................................74

10.13* Third  Restatement  of the  PSC  Inc.  401(K)  Plan  dated  as of July 1,
     1997.....................................................................78

10.14Credit  Agreement  dated July 12,  1996  among PSC  Acquisition,  Inc.,  as
     Borrower,  PSC Inc. and  Guarantor,  the Initial  Lenders named therein and
     Fleet Bank as Initial Issuing Bank and Administrative  Agent, together with
     Form of Term A Note,  Form of Term B Note and Form of Working  Capital Note
     (incorporated by reference to Exhibit 10.2 of the 1996 8-K).

10.15First  Amendment  dated as of  September  27, 1996 to the Credit  Agreement
     dated as of July 12, 1996 among PSC Scanning  Inc., as Borrower,  PSC Inc.,
     as Guarantor,  the financial  institutions  party thereto and Fleet Bank as
     initial Issuing Bank and administrative agent (incorporated by reference to
     Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the quarter
     ended September 27, 1996 (the "September 27, 1996 Form 10-Q")).

10.16Second  Amendment dated as of July 4, 1997 to the Credit Agreement dated as
     of July 12,  1996  among PSC  Scanning  Inc.,  as  Borrower,  PSC Inc.,  as
     Guarantor,  the  financial  institutions  party  thereto  and Fleet Bank as
     initial Issuing Bank and administrative agent (incorporated by reference to
     Exhibit 10.3 of the July 4, 1997 Form 10-Q).

10.17Amendment  Three dated as of August 13, 1997 to the Credit  Agreement dated
     as of July 12, 1996 among PSC  Scanning  Inc.,  as Borrower,  PSC Inc.,  as
     Guarantor,  the  financial  institutions  party  thereto  and Fleet Bank as
     initial Issuing Bank and administrative agent (incorporated by reference to
     Exhibit  10.5 of the  Company's  Quarterly  Report on Form  10-Q/A  for the
     quarter ended July 4, 1997 (the "July 4, 1997 Form 10-Q/A").

10.18Consent  dated as of December 8, 1997 to the Credit  Agreement  dated as of
     July 12, 1996 among PSC Scanning Inc., as Borrower, PSC Inc., as Guarantor,
     the financial  institutions party thereto and Fleet Bank as initial Issuing
     Bank and administrative agent...........................................107

10.19Securities   Purchase  Agreement  dated  July  12,  1996  among  PSC  Inc.,
     SpectraScan, Inc. and Equitable Life Assurance Society of the United States
     (separate but identical  Securities  Purchase  Agreements were addressed to
     each  of  the  Other   Purchasers   of  the  Senior   Subordinated   Notes)
     (incorporated by reference to Exhibit 10.1 of the 1996 8-K).

10.20Amendment No. 1 dated October 10, 1996 to  Securities  Purchase  Agreements
     among PSC Inc., PSC Scanning Inc., and Equitable Life Assurance  Society of
     the United States (separate but identical amendments were addressed to each
     of the other purchasers of the Senior Subordinated Notes)  (incorporated by
     reference to Exhibit 10.2 of the September 27, 1996 10-Q).

10.21Amendment No. 2 dated July 4, 1997 to Securities  Purchase Agreements among
     PSC Inc., PSC Scanning  Inc.,  and Equitable Life Assurance  Society of the
     United States (separate but identical  amendments were addressed to each of
     the other  purchasers of the Senior  Subordinated  Notes)  (incorporated by
     reference to Exhibit 10.4 of the July 4, 1997 Form 10-Q).
<PAGE>

10.22Amendment  No. 3 dated August 18, 1997 to  Securities  Purchase  Agreements
     and Warrants among PSC Inc., PSC Scanning Inc., and the Purchasers named in
     the Securities  Purchase  Agreements  (incorporated by reference to Exhibit
     10.6 of the July 4, 1997 Form 10-Q/A).

10.23Consent  dated as of December 29, 1997 to  Securities  Purchase  Agreements
     and Warrants among PSC Inc., PSC Scanning Inc., and the Purchasers named in
     the Securities Purchase agreements......................................109

10.24Stock  and  Warrant  Purchase  Agreement  dated  September  4,  1997 by and
     between PSC Inc. and Hydra Investissements S.A.  (incorporated by reference
     to Exhibit 10.1 of the 1997 Form 8-K).

10.25Registration  and Investor Rights Agreement dated September 10, 1997 by and
     between PSC Inc. and Hydra Investissements S.A.  (incorporated by reference
     to Exhibit 10.2 of the 1997 Form 8-K).

22.1 Subsidiaries of Registrant..............................................115

24.1 Consent   of    Independent    Public    Accountant,    dated   March   25,
     1998....................................................................116

     (b):Reports on Form 8-K:

         Report on Form 8-K, dated December 30, 1997

     *   Management contract or compensatory plan or arrangement



<PAGE>


                                   SIGNATURES

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

Dated:  March 24, 1998                     PSC Inc.

                                           /s/ Robert C. Strandberg
                                           Robert C. Strandberg
                                           President and Chief Executive 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.

Date:  March 24, 1998                      Principal Executive Officer

                                           /s/ Robert C. Strandberg
                                           Robert C. Strandberg
                                           President and Chief Executive Officer





 Date:  March 24, 1998                     Chief Financial Officer

                                           /s/ William J. Woodard
                                           William J. Woodard
                                           Vice President, Chief Financial
                                           Officer and Treasurer




Date:  March 24, 1998                     Principal Accounting Officer

                                          /s/ Michael J. Stachura
                                          Michael J. Stachura
                                          Vice President, Finance



<PAGE>


Date:  March 24, 1998               /s/ Jay M. Eastman
                                    ------------------
                                    Jay M. Eastman
                                    Director

Date:  March 24, 1998               /s/ Robert S. Ehrlich
                                    ---------------------
                                    Robert S. Ehrlich
                                    Director, Chairman of the Board

Date:  March 24, 1998               /s/ James W. Henry
                                    ------------------
                                    James W. Henry
                                    Director

Date: March 24, 1998                /s/ Donald K. Hess
                                    ------------------
                                     Donald K. Hess
                                     Director

Date: March 24, 1998                /s/ Thomas J. Morgan
                                    --------------------
                                    Thomas J. Morgan
                                    Director

Date:  March 24, 1998               /s/ James C. O'Shea
                                    -------------------
                                    James C. O'Shea
                                    Director

Date:  March 24, 1998               /s/ Jack E. Rosenfeld
                                    ---------------------
                                    Jack E. Rosenfeld
                                    Director

Date:  March 24, 1998               /s/ Justin L. Vigdor
                                    --------------------
                                    Justin L. Vigdor
                                    Director

Date:  March 24, 1998               /s/ Romano Volta
                                    ----------------
                                    Romano Volta
                                    Director

<PAGE>


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To PSC Inc.:

We have audited the accompanying  consolidated balance sheets of PSC Inc. (a New
York  corporation)  and  subsidiaries  as of December 31, 1997 and 1996, and the
related  consolidated  statements of operations,  shareholders'  equity and cash
flows for each of the three years in the period ended  December 31, 1997.  These
financial  statements and the schedule referred to below are the  responsibility
of the  Company's  management.  Our  responsibility  is to express an opinion on
these financial statements and the schedule based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects, the financial position of PSC Inc. and subsidiaries as of
December 31, 1997 and 1996,  and the results of their  operations and their cash
flows for each of the three years in the period  ended  December  31,  1997,  in
conformity with generally accepted accounting principles.

Our  audits  were  made for the  purpose  of  forming  an  opinion  on the basic
financial  statements  taken as a whole.  The schedule  listed in Item 14(a)2 is
presented  for  purposes  of  complying   with  the   Securities   and  Exchange
Commission's  rules  and is not  part of the  basic  financial  statements.  The
schedule has been subjected to the auditing  procedures  applied in the audit of
the  basic  financial  statements  and,  in our  opinion,  fairly  states in all
material  respects  the  financial  data  required  to be set forth  therein  in
relation to the basic financial statements taken as a whole.

/s/ Arthur Andersen LLP
Rochester, New York
January 30, 1998



<PAGE>

<TABLE>

                            PSC INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                (All amounts in thousands, except per share data)
<CAPTION>

                                     ASSETS

                                                                 December 31,
                                                       -------------------------------
                                                               1997             1996
                                                       --------------    -------------
<S>                                                             <C>        <C>
Current Assets:
  Cash and cash equivalents .................................   $  2,271   $ 10,838
  Accounts receivable, net of allowance for doubtful accounts
    of $1,169 in 1997 and $1,101 in 1996 ....................     35,094     29,501
  Inventories, net ..........................................     17,723     18,306
  Prepaid expenses and other ................................      1,569      1,244
                                                                --------   --------
     Total current assets ...................................     56,657     59,889
Property, Plant and Equipment, net ..........................     35,469     35,612
Deferred Tax Assets .........................................     23,576     24,773
Intangible and Other Assets, net ............................     57,096     63,087
                                                                ========   ========
     Total assets ...........................................   $172,798   $183,361
                                                                ========   ========

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities:
  Current portion of long-term debt ........................   $ 12,406   $  9,459
  Accounts payable .........................................     18,000     15,681
  Accrued expenses .........................................      7,405      9,911
  Accrued payroll and related employee benefits ............      5,559      7,509
  Accrued acquisition related restructuring costs...........      1,175      4,009
                                                                --------   --------
     Total current liabilities .............................     44,545     46,569
Long-Term Debt, less current maturities ....................     96,148    117,994
Other Long-Term Liabilities ................................      2,775      3,497
   Commitments and Contingencies

Shareholders' Equity:
   Preferred shares, par value $.01; 10,000 authorized,
    110 and 0 issued and outstanding at December 31,
    1997 and 1996, respectively.
    ($11,000 aggregate liquidation value) ...................         1               --
   Common shares, par value $.01; 40,000 authorized,
    11,390 and 11,161 issued at December 31, 1997 and 1996,
    respectively ............................................        114              112
     Additional paid-in capital .............................     66,734           54,891
     Retained earnings/(Accumulated deficit) ................    (36,543)         (39,432)
     Cumulative translation adjustment ......................       (739)             (33)
     Less - 39 treasury shares, repurchased at cost .........       (237)            (237)
                                                              --------------    -------------
        Total shareholders' equity                                29,330           15,301
                                                              ==============    =============
        Total liabilities and shareholders' equity              $172,798         $183,361
                                                              ==============    =============
</TABLE>

See accompanying notes to the Consolidated Financial Statements.



<PAGE>

<TABLE>


                            PSC INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                (All amounts in thousands, except per share data)
<CAPTION>


                                                                              Year Ended December 31,
                                                                 -----------------------------------------------
                                                                       1997            1996              1995
                                                                 -------------    -------------    -------------

<S>                                                                  <C>              <C>               <C>
   Net Sales ................................................        $207,840         $146,051          $87,516
   Cost of Sales ............................................         122,995           83,675           50,634
                                                                 -------------    -------------    -------------
        Gross profit ........................................          84,845           62,376           36,882

   Operating Expenses:
        Engineering, research and development ...............          13,018           11,069            4,962
        Selling, general and administrative .................          44,154           37,855           23,024
        Amortization of intangibles resulting from business
               acquisitions .................................           6,715            3,564              877
        Severance and other costs ...........................           4,191               --               --
        Acquisition related restructuring and other costs ...              --           70,068               --
                                                                 -------------    -------------    -------------
              Income/(loss) from operations .................          16,767         (60,180)            8,019

   Interest and Other Income/(Expense):
        Interest expense ....................................        (12,563)          (5,835)            (306)
        Interest income .....................................             440              568              594
        Other income/(expense) ..............................             107            (480)              388
                                                                 -------------    -------------    -------------
                                                                     (12,016)          (5,747)              676
                                                                 -------------    -------------    -------------

   Income/(Loss) from Continuing Operations Before
        Income Tax Provision/(Benefit) ......................           4,751         (65,927)            8,695
   Income Tax Provision/(Benefit) ...........................           1,761         (24,393)            3,246
                                                                 -------------    -------------    -------------
   Income/(Loss) from Continuing Operations .................           2,990         (41,534)            5,449

   Discontinued Operations:
        Gain/(loss)from discontinued operations, net of tax .             164            (229)               --
        Loss on disposal of discontinued operations .........           (265)          (5,217)               --
                                                                 -------------    -------------    -------------
   Total Loss from Discontinued Operations ..................           (101)          (5,446)               --
                                                                 =============    =============    =============
   Net Income/(Loss) ........................................          $2,889        $(46,980)           $5,449
                                                                 =============    =============    =============

   Net Income/(Loss) Per Common and
        Common Equivalent Share:
   Basic:
        Continuing operations ...............................           $0.27          $(3.96)            $0.58
        Discontinued operations .............................          (0.01)           (0.52)               --
                                                                 =============    =============    =============
        Net income/(loss) ...................................           $0.26          $(4.48)            $0.58
                                                                 =============    =============    =============
   Diluted:
        Continuing operations ...............................           $0.25          $(3.96)            $0.54
        Discontinued operations .............................          (0.01)           (0.52)               --
                                                                 =============    =============    =============
        Net income/(loss) ...................................           $0.24          $(4.48)            $0.54
                                                                 =============    =============    =============
   Weighted Average Number of Common
        and Common Equivalent Shares Outstanding:
        Basic ...............................................          11,197           10,490            9,329
        Diluted .............................................          11,843           10,490           10,013
</TABLE>

See accompanying notes to the Consolidated Financial Statements.

<PAGE>




                            PSC INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                           (All amounts in thousands)

<TABLE>
<CAPTION>


                                                                           Year Ended December 31,
                                           ---------------------------------------------------------------------------------------
                                                      1997                           1996                           1995
                                           ----------------------------     ------------------------      ------------------------

                                           Shares          Amount          Shares          Amount         Shares         Amount
                                          ----------    --------------    ----------    -------------    ----------    -----------


<S>                                            <C>               <C>        <C>                 <C>          <C>             <C>
Preferred Shares
   Balance, beginning of year ..........         --               $--            --              $--            --            $--
   Issuance of preferred shares ........        110                 1            --               --            --             --
                                          ----------    --------------    ----------    -------------    ----------    -----------
    Balance, end of year ...............        110                $1            --              $--            --            $--
                                          ==========    ==============    ==========    =============    ==========    ===========

Common Shares
   Balance, beginning of year ..........     11,122              $112         9,946             $100         7,433           $ 75
   Issuance of shares pursuant to
     Employee Stock Purchase Plan ......         67                 1            26               --             9             --
   Issuance of common shares ...........         --                --           977               10         2,310             23
   Exercise of options .................        162                 1           173                2           194              2
                                          ==========    ==============    ==========    =============    ==========    ===========
   Balance, end of year ................     11,351              $114        11,122             $112         9,946           $100
                                          ==========    ==============    ==========    =============    ==========    ===========

Additional Paid-In Capital
   Balance, beginning of year ..........                      $54,891                       $ 45,881                      $20,288
   Issuance of shares pursuant to
     Employee Stock Purchase Plan ......                          390                            201                           87
   Exercise of options                                          1,150                          1,079                        1,269
   Issuance of common shares, net ......                           --                          6,990                       23,552
   Issuance of preferred shares, net ...                        9,595                             --                           --
   Issuance of warrants ................                          617                            600                           --
   Tax benefit from exercise or early
     disposition of stock options ......                           91                            140                          685
                                                        ==============                  =============                  ===========
   Balance, end of year ................                      $66,734                       $ 54,891                      $45,881
                                                        ==============                  =============                  ===========


Retained Earnings/(Accumulated
Deficit)
   Balance, beginning of year ..........                    $(39,432)                     $    7,548                       $2,099
   Net income/(loss) ...................                        2,889                       (46,980)                        5,449
                                                        ==============                  =============                  ===========
   Balance, end of year ................                    $(36,543)                      $(39,432)                       $7,548
                                                        ==============                  =============                  ===========

Cumulative Translation Adjustment
   Balance, beginning of year ..........                      $(  33)                         $   35                       $    8
   Translation adjustment ..............                        (706)                           (68)                           27
                                                        ==============                  =============                  ===========
   Balance, end of year ................                      $ (739)                         $( 33)                        $  35
                                                        ==============                  =============                  ===========

Treasury Shares
   Balance, beginning of year ..........                       $(237)                         $(237)                       $(237)
   Shares repurchased ..................                           --                             --                           --
                                                        ==============                  =============                  ===========
   Balance, end of year ................                       $(237)                         $(237)                       $(237)
                                                        ==============                  =============                  ===========
</TABLE>



       See accompanying notes to the Consolidated Financial Statements.

<PAGE>

<TABLE>


                            PSC INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                           (All amounts in thousands)
<CAPTION>

                                                                             Year Ended December 31,
                                                                     -----------------------------------------
                                                                          1997        1996              1995
                                                                     -----------   ------------    -----------
<S>                                                                      <C>         <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income/(loss) ................................................       $2,889      ($46,980)         $5,449
Adjustments to reconcile net income/(loss) to
  net cash provided by operating activities:
      Depreciation and amortization ..............................       13,735          9,169          2,784
      (Gain)/loss on disposition of assets .......................          109          3,860          (161)
      Acquired research and development write-off ................           --         60,100             --
      Loss on disposal of discontinued operations ................          265          5,217             --
      Deferred tax assets ........................................        1,197       (23,033)            668
      (Increase) decrease in assets:
         Accounts receivable, net ................................      (6,705)          1,760        (2,669)
         Inventories .............................................          581        (1,199)        (4,031)
         Prepaid expenses and other ..............................           80          (147)            301
      Increase (decrease) in liabilities:
         Accounts payable ........................................        2,467          1,461            699
         Accrued expenses ........................................      (3,190)        (5,535)          1,297
         Accrued payroll and related employee benefits ...........      (1,855)          6,272          (333)
         Accrued acquisition related restructuring costs .........      (3,830)          4,278        (1,107)
                                                                     -----------   ------------    -----------
           Net cash provided by operating activities .............        5,743         15,223          2,897
                                                                     -----------   ------------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .............................................      (6,557)        (4,843)        (7,418)
Cash paid for acquisition of business ............................           --       (10,124)             --
Additions to intangible and other assets .........................        (343)        (1,238)        (4,443)
Issuance of notes for stock option activity ......................           --          (382)          (593)
Repayment of notes for stock option activity .....................          278             --             --
Proceeds from sale of marketable securities ......................           --          4,167             --
                                                                     -----------   ------------    -----------
           Net cash used in investing activities .................      (6,622)       (12,420)       (12,454)
                                                                     -----------   ------------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
Additions to long-term debt ......................................        5,000            ---          1,046
Additions to other long-term liabilities .........................        1,398            648            230
Principal repayments of long-term debt ...........................     (23,899)          (105)       (14,126)
Payment of other long-term liabilities ...........................        (655)             --          (420)
Exercise of options and the issuance of common shares and warrants        1,542          1,882         24,933
Issuance of preferred shares and warrants, net ...................       10,213             --             --
Tax benefit from exercise or early disposition of stock options ..           91            140            685
                                                                     -----------   ------------    -----------
           Net cash (used in) provided by financing activities ...      (6,310)          2,565         12,348
                                                                     -----------   ------------    -----------
Foreign currency translation .....................................      (1,378)           (68)             27
                                                                     -----------   ------------    -----------
Net Increase (Decrease) in Cash and Cash Equivalents .............      (8,567)          5,300          2,818

CASH AND CASH EQUIVALENTS:
                Beginning of year ................................       10,838          5,538          2,720
                                                                     ===========   ============    ===========
                End of year ......................................      $ 2,271        $10,838         $5,538
                                                                     ===========   ============    ===========
Supplemental disclosures of cash flow information:
  Interest paid ..................................................      $13,804         $3,994        $   306
  Income taxes paid ..............................................      $   438         $  833        $ 3,009
  Capital leases .................................................      $    --         $   35        $   131
</TABLE>

See accompanying notes to the Consolidated Financial Statements.


<PAGE>



                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

1.  DESCRIPTION OF BUSINESS

         PSC Inc.  (the  Company)  manufactures  the  world's  broadest  line of
handheld and fixed position bar code readers,  verifiers,  integrated  sortation
and  point-of-sale  scanning  systems.  The Company has  developed  products for
automatic  data  collection at every stage of the product  supply chain from raw
material, manufacturing and warehousing, to logistics, transportation, inventory
management and  point-of-sale.  These products are used  throughout the world in
food, general retail, health care and other industries, and in government.

         The Company's corporate headquarters are located in the Rochester,  New
York suburb of Webster. The Company designs,  manufactures,  sells,  distributes
and services its products from world-class  manufacturing facilities in Webster,
New York and Eugene,  Oregon. These products are sold through original equipment
manufacturers,  value-added resellers,  distributors,  systems integrators and a
professional sales force worldwide. The Company has sales and service operations
in the Americas, Europe, Asia and Australia.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

         The  consolidated   financial   statements   include  the  accounts
of PSC Inc. and its  wholly-owned  subsidiaries.  All  significant  intercompany
accounts and transactions are eliminated in consolidation.

Cash and Cash Equivalents

         Cash and cash  equivalents are highly liquid  investments with original
maturities  of  three  months  or  less.  The  cost  of  the  cash   equivalents
approximates fair market value.

Inventories

         Inventories  are  stated  at the  lower  of cost or  market  using  the
first-in, first-out method.

Property, Plant and Equipment

         Property,  plant and equipment is recorded at cost and includes certain
capitalized  leases.  For  financial   reporting   purposes,   depreciation  and
amortization  are computed  using the  straight-line  method over the  following
estimated useful lives:

        Building and improvements                        10-40 years
        Office furniture and equipment                     3-7 years
        Production equipment                               3-8 years
        Leasehold improvements                            3-15 years

         Equipment under capital leases and leasehold improvements are amortized
using the straight-line method over the shorter of the estimated useful lives of
the assets or the lease term.





<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

Intangibles Resulting from Business Acquisitions

Intangibles resulting from business  acquisitions  represent the excess purchase
price over the fair value of net assets  acquired  and are  amortized  using the
straight-line  method over five to ten years,  their  current  estimated  useful
lives.

Other Intangibles

         Other intangibles,  which consist of technology and license agreements,
patents and  trademarks,  are recorded at cost.  Amortization is calculated on a
straight-line  basis over periods ranging from two to five years,  their current
estimated useful lives.

         The  Company   reviews  its  long-lived   assets,   including   certain
intangibles and goodwill,  in accordance with Statement of Financial  Accounting
Standards No. 121,  "Accounting  for the  Impairment  of  Long-lived  Assets and
Long-lived  Assets to be Disposed of" for impairment  whenever events or changes
in  circumstances  indicate  that the  carrying  amount  of an asset  may not be
recoverable.  If such events or changes in circumstances are present,  a loss is
recognized to the extent the carrying value of the asset is in excess of the sum
of the undiscounted  cash flows expected to result from the use of the asset and
its eventual disposition.

Income Taxes

         Income  taxes  are  accounted  for  in  accordance  with  Statement  of
Financial  Accounting  Standards No. 109 (SFAS No. 109)  "Accounting  for Income
Taxes." SFAS No. 109 requires an asset and liability  method of  accounting  for
income  taxes.  Under the asset and  liability  method,  deferred tax assets and
liabilities are recognized for temporary differences between financial statement
and  income  tax  bases of assets  and  liabilities.  Deferred  tax  assets  and
liabilities  are measured using tax rates expected to apply to taxable income in
the years  that the  temporary  differences  are  expected  to be  realized.  In
addition,  the  amount of any  future tax  benefits  is  reduced by a  valuation
allowance until it is more likely than not that such benefits will be realized.

Net Income per Common and Common Equivalent Share

         In February  1997,  Statement of Financial  Accounting  Standards  No.
128 (SFAS No.  128),  "Earnings  Per Share" was  issued.  SFAS No. 128  replaces
Accounting  Principles  Board  Opinion  No. 15.  SFAS No. 128  replaces  primary
Earnings  Per Share  (EPS) with basic EPS.  Basic EPS is  computed  by  dividing
reported  earnings  available to common  shareholders  by the  weighted  average
shares  outstanding during the year. No dilution for common share equivalents is
included.  Fully  diluted  EPS, now called  diluted EPS,  also is required to be
presented.  The  Company  adopted  SFAS No. 128  retroactively  for all  periods
presented.  Accordingly,  the Company has restated its previously  presented EPS
amounts.

Foreign Currency Translation

         The  financial  statements of foreign  operations  are translated  into
U.S. dollars in accordance with Statement of Financial  Accounting Standards No.
52 "Foreign Currency Translation." Accordingly, all
<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

assets and liabilities are translated at year-end  exchange rates. The gains and
losses  that result from this  process are shown in the  cumulative  translation
adjustment  account in the  shareholders'  equity  section of the balance sheet.
Operating  transactions  are  translated at weighted  average  rates  prevailing
during the year.  Transaction gains and losses are  reflected in net  income and
were not material.

Derivatives

         The Company monitors its exposure to interest rate and foreign currency
exchange risk. The Company has limited  involvement  with  derivative  financial
instruments  and does  not use  them for  trading  purposes.  The  Company  uses
derivative instruments solely to reduce the financial impact of these risks.

Interest Rate Risk:

         The  Company's  exposure  to  interest  rate  changes  relates  to  its
long-term  debt. The Company has entered into interest rate swap agreements with
its senior  lending  banks in  accordance  with the terms of the  senior  credit
agreement.  The Company uses these  interest rate swap  agreements to reduce its
exposure to interest  rate  changes.  The  differentials  to be received or paid
under these  interest  rate swap  agreements  are  recognized  as a component of
interest expense in the consolidated statements of operations.

Foreign Currency Exchange Rate Risk:

         The Company's  exposure to foreign  currency  exchange  changes relates
primarily to its  international  subsidiaries.  Sales to certain  countries  are
denominated in their local  currency.  The Company may  occasionally  enter into
forward  foreign  exchange  contracts as a hedge against  currency  fluctuations
relating to these foreign  transactions  and commitments  denominated in foreign
currencies.   The  foreign  exchange  contracts  generally  have  maturities  of
approximately 30 days and require the Company to exchange foreign currencies for
U.S. dollars at maturity,  at rates agreed to at the inception of the contracts.
Gains and losses on forward  contracts are offset  against the foreign  exchange
gains  and  losses  on the  underlying  hedged  items  and are  recorded  in the
Consolidated Statements of Operations.  There were no foreign exchange contracts
outstanding at December 31, 1997.

Fair Value of Financial Instruments

         The carrying amounts of cash and cash equivalents,  trade  receivables,
other current assets, accounts payable, and amounts included in accruals meeting
the definition of a financial instrument,  approximate fair value because of the
short-term  maturity  of these  instruments.  The  carrying  value  and  related
estimated fair values for the Company's remaining  financial  instruments are as
follows:

 <TABLE>
<CAPTION>

                                                    1997                     1996
                                            ----------------------    -----------------------
                                            Carrying       Fair        Carrying       Fair
                                             Amount        Value        Amount        Value
                                            --------    ----------    ---------    ----------
<S>                                         <C>           <C>         <C>          <C>
Interest rate swap agreements               $     --      $  451      $     --      $     --
Long-term debt, including current portion   $108,554      $108,554    $127,453      $127,453
</TABLE>

     Based on borrowing rates currently  available to the Company for loans with
similar terms and average  maturities,  the fair value of its debt  approximates
its recorded  value.  Interest rate swap  agreements  are estimated by obtaining
quotes from brokers and reflecting the cost to terminate the agreements.

<PAGE>



                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

Product Warranty

         The  Company's  products  have a  warranty  period of 12 to 30  months.
Estimated warranty costs are provided at the time of sale. The Company maintains
an accrual for warranty  claims and adjusts this accrual  periodically  based on
historical experience and known warranty claims.

Research and Development Costs

         All research and development costs are expensed as incurred.

Revenue Recognition

         Revenue from sales of the  Company's  scanning  products is  recognized
upon  shipment.  In  conjunction  with these sales,  field  service  maintenance
agreements  are entered  into for certain  products.  Maintenance  revenues  are
deferred and recognized ratably over the term of the related maintenance period,
which is  typically  one to three  years.  Revenue  from sales of the  Company's
self-checkout  systems is recognized upon  installation  and acceptance from the
customer.

Use of Estimates

         The  preparation of financial  statements in conformity  with generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

Reclassification

         Certain amounts in prior years have been reclassified to conform to the
1997 presentation.

3.  ACQUISITIONS AND DISPOSITIONS

         On July 12, 1996,  the Company  completed its purchase  agreement  with
Spectra-Physics AB of Sweden to acquire Spectra-Physics  Scanning Systems, Inc.,
TxCOM S.A. and related businesses (Spectra).  Spectra, which is headquartered in
Eugene,  Oregon,  is one of the world's leading  manufacturers of countertop and
in-counter   fixed   position  bar  code   scanners  for  retail   point-of-sale
applications.  The purchase price was approximately $140.0 million. The purchase
was funded by $125.0  million in cash,  $10.0  million in the  Company's  common
shares less a $3.0 million  discount as the shares were  unregistered and a $5.0
million subordinated promissory note. The $125.0 million cash portion was funded
by a  combination  of the  Company's  cash,  senior  debt of $92.5  million  and
subordinated  debt of $30.0  million.  The  acquisition  was  accounted for as a
purchase and is included in the 1996 Consolidated Financial
<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)



Statements since the date of acquisition. The Company allocated $60.1 million of
the purchase price to acquired  in-process  research and development as required
by generally accepted accounting  principles,  resulting in a one-time charge to
the Company's earnings in the third quarter of 1996. The remaining excess of the
purchase  price  over the fair value of net assets  acquired  was  approximately
$58.0 million and is being amortized on a straight-line basis over 10 years.

         The  following  table sets  forth the  unaudited  pro forma  results of
operations  of the Company for the years ended  December 31, 1996 and 1995.  The
unaudited  pro forma  results of  operations  assume that the  operations of the
Company were  combined with those of Spectra as if the  acquisition  occurred on
January 1, 1995.  The unaudited  pro forma  results of operations  are presented
after giving effect to certain  adjustments  for  depreciation,  amortization of
goodwill,  interest expense on the acquisition  financing and related income tax
effects. The unaudited pro forma results of operations were based upon currently
available  information and upon certain  assumptions  that the Company  believes
were reasonable. The unaudited pro forma results do not purport to be indicative
of the  results  that  actually  would have been  achieved  during  the  periods
indicated and are not intended to be indicative of future  results.

                                                          Pro Forma
                                                      Twelve Months Ended
                                                      -------------------
                                                   12/31/96           12/31/95
                                                   ----------         ---------
Net sales ......................................   $210,961           $189,143
Income/(loss) from operations ..................   (51,800)             15,444
Income/(loss) from continuing operations .......   (40,148)              1,931
Total loss from discontinued operations ........    (5,446)                 --
Net income/(loss) ..............................   (45,594)              1,931
Net income/(loss) per common and common
   equivalent share:
Basic:
   Continuing operations ....................... $   (3.83)         $     0.21
   Discontinued operations .....................     (0.52)                 --
                                                     ------         -----------
   Net income/(loss) ........................... $   (4.35)         $     0.21
                                                 ==========         ==========
Diluted:
   Continuing operations ....................... $   (3.65)         $     0.17
   Discontinued operations .....................     (0.49)                 --
                                                     ------         -----------
   Net income/(loss) ........................... $   (4.14)         $     0.17
                                                 ==========         ==========
Weighted average shares outstanding:
   Basic .......................................     10,490              9,329
   Diluted .....................................     11,008             11,216
<PAGE>



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

         In connection with the acquisition,  liabilities  assumed and cash paid
were as follows:

         Fair value assets acquired ............ $161,162
         Liabilities assumed ...................   17,138
           Total consideration paid ............  144,024
         Less issuance of stock ................    7,000
         Less amounts borrowed .................  126,900
                                                  -------
           Net cash paid for acquisition .......$  10,124
                                                =========

         In April 1995, the Company  completed the sale of substantially  all of
the assets  related to its image products  business.  This resulted in a gain of
approximately $161 which was included in other income in 1995.

4.  INVENTORY

         Inventory consists of the following at December 31:

                                    1997             1996
                                -----------      ------------
           Raw materials ......    $10,979           $10,688
           Work-in-process ....      3,727             3,547
           Finished goods .....      3,017
                                                       4,071
                                ===========      ============
                                   $17,723           $18,306
                                ===========      ============


5.  PROPERTY, PLANT AND EQUIPMENT

     Property,  plant  and  equipment,  at cost,  consist  of the  following  at
December 31:
                                                         1997           1996
                                                    ------------   ------------
Land                                                    $ 2,312        $ 2,304
Building and improvements                                17,782         17,592
Office furniture and equipment                           11,169          9,583
Production equipment                                     16,529         13,849
Leasehold improvements                                      701            509
                                                    ------------   ------------
                                                         48,493         43,837
  Less:  accumulated depreciation and amortization       13,024          8,225
                                                    ============   ============
                                                        $35,469        $35,612
                                                    ============   ============

Depreciation  expense for 1997,  1996 and 1995  amounted  to $6,478,  $4,947 and
$1,673,  respectively.  Amortization  of capital  lease  assets is  included  in
depreciation expense.
<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

6.  INTANGIBLE AND OTHER ASSETS
Intangible and other assets consist of the following at December 31:

                                                        1997           1996
                                                     ------------  ------------
Intangibles resulting from business acquisitions         $66,846        $65,750

Other intangibles                                          2,565          2,234

Other assets                                                 691          1,341
                                                     -------------  ------------
                                                          70,102         69,325
   Less:  accumulated amortization                        13,006          6,238
                                                     ------------   ------------
                                                         $57,096         $63,087
                                                     ============   ============

         Amortization expense for 1997, 1996 and 1995 amounted to $7,257, $4,222
and $1,111, respectively.

SCHEDULE 7.                ACCRUED EXPENSES

Accrued expenses consist of the following at December 31:

                                        1997               1996
                                    -----------        -----------
       Accrued warranty ..........      $1,818             $1,641
       Accrued royalty ...........         862              1,261
       Accrued interest ..........         105              1,687
       Accrued relocation ........         939              1,185
       Deferred revenue ..........         758                714
       Other expenses ............       2,923              3,423
                                    ===========        ===========
                                        $7,405             $9,911
                                    ===========        ===========

8.  LONG-TERM DEBT

         Long-term debt consists of the following at December 31:

                                               1997              1996
                                        ----------------    -------------
  Senior term loan A .................         $ 47,000        $  55,000
  Senior term loan B .................           24,000           25,000
  Senior revolving credit ............            3,000           12,500
  Subordinated term loan .............           29,488           29,428
  Subordinated promissory note .......            4,688            5,000
  Other ..............................              378              525
                                        ----------------    -------------
                                                108,554          127,453
    Less:  current maturities ........           12,406            9,459
                                        ----------------    -------------
                                               $ 96,148         $117,994
                                        ================    =============

         During  1996,  the Company  negotiated a series of debt  agreements  in
connection  with the funding of its  acquisition  of  Spectra.  Term loan A is a
senior loan with five lenders, having a final maturity in June

<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

2001,  at a current  floating  interest rate of 8.7% and a swapped fixed rate of
9.4%. Term loan B is a senior loan with four lenders, having a final maturity in
December 2002, at a current  floating  interest rate of 9.2% and a swapped fixed
rate of 9.9%. The swaps for both loans expire on September 30, 1998.

         The revolving credit is with the term loan lenders, matures in 2001 and
has a  current  floating  interest  rate of 9.0%.  The  total  revolving  credit
facility is $20.0 million,  of which $3.0 million is outstanding at December 31,
1997.  The  unused  portion of the  revolving  credit  facility  is subject to a
commitment  fee of between  0.375% and 0.5%.  The senior  debt  facilities  have
collateral in all of the assets of the Company.

         The  subordinated  term loan is from five  lenders,  at a fixed rate of
11.25%,  with principal  payments  starting in June 2003 and a final maturity in
June 2006.  This debt has an associated  unamortized  discount of $512 which has
been netted against the total outstanding balance of $30.0 million.

         The  subordinated  promissory  note  matures  in 2001 and has a current
floating  interest rate of 9.5%. The subordinated  term loan and promissory note
are unsecured.

         The other debt is principally composed of capital lease obligations.

         The senior debt and subordinated term loan agreements  restrict payment
of dividends,  limit stock  repurchases  and require the  maintenance of certain
financial ratios.  The Company was in compliance with all of these covenants and
ratios as of December 31, 1997.

Long-term debt maturities are as follows for years ending December 31:


                                   1998                      $  12,406
                                   1999                         14,402
                                   2000                         16,281
                                   2001                         25,449
                                   2002                         10,507
                                   Thereafter                   29,509
                                                       ----------------
                                                              $108,554
                                                       ================

         The Company is a guarantor under a mortgage  agreement through February
2001 relating to its former principal manufacturing facility up to $500.


<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

9. INCOME TAXES

          The  provision  for  (benefit  from)  income  taxes  consisted  of the
following for the years ended December 31:

                                       1997             1996           1995
                                 ------------     -------------    -----------
Current:
  Federal ....................        $  244        $  (1,589)         $1,686
  State ......................            59                65            341
  Foreign ....................           261               164            551
Deferred:
  Federal ....................         1,658          (21,176)            585
  State ......................         (461)           (1,857)             83
                                 ============     =============    ===========
      Total ..................        $1,761         $(24,393)         $3,246
                                 ============     =============    ===========

         A reconciliation between the statutory U.S. federal income tax rate and
the Company's effective tax rate is as follows for the years ended December 31:

                                   1997          1996           1995
                                -----------    ----------    -----------
Computed "expected" tax expense   34.0%          34.0%         34.0%
Change in valuation reserve         --           2.3%          (4.7%)
State income taxes, net of
  federal income tax benefit       4.2%          1.8%           3.2%
Goodwill amortization              2.7%          0.2%           1.4%
FSC benefit                       (3.7%)        (0.1%)         (1.0%)
Meals and entertainment            2.1%          0.3%           0.7%
Miscellaneous items, net          (2.2%)        (1.5%)          3.7%
                                -----------    ----------    -----------
                                  37.1%          37.0%         37.3%
                                ===========    ==========    ===========

The deferred tax assets/(liabilities) are comprised of the following at December
31:

                                                         1997          1996
                                                    ------------   ------------
Acquired in-process research and development costs .    $21,703        $23,305
Intangibles resulting from business acquisitions ...    (2,869)        (1,079)
Tax credit carryforward ............................      1,271             --
Warranty reserve ...................................      1,170          1,175
Severance accrual ..................................      1,072             --
Inventory reserve ..................................      1,018          1,405
Acquisition related restructuring and other costs ..        494          1,828
Other, net .........................................      1,283            275
                                                    ------------   ------------
                                                         25,142         26,909
Less:  valuation allowance .........................    (1,566)        (2,136)
                                                    ============   ============
Net deferred tax asset .............................    $23,576        $24,773
                                                    ============   ============
<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)


         In  assessing  the  realizability  of deferred  tax assets,  management
considers  whether it is more  likely  than not that some  portion or all of the
deferred  tax assets  will not be  realized.  Management  considers  among other
things,  the scheduled  reversal of deferred tax  liabilities,  projected future
taxable  income,   tax  planning   strategies  and  positions  taken  by  taxing
authorities on various issues related to the  deductibility  of certain costs in
making  this  assessment.  The Company has  recorded a  valuation  allowance  to
reflect the estimated  realizable amount of deferred tax assets and it primarily
relates to state tax benefits. The deferred tax asset related to the acquisition
of Spectra has been adjusted along with the related valuation allowance.

10.  COMMITMENTS AND CONTINGENCIES

Operating Lease Agreements

         Certain  equipment  and  properties  are  rented  under   noncancelable
operating leases that expire at various dates through 2002. Total rental expense
under operating leases was approximately  $2,214, $1,214 and $786, for the years
ended December 31, 1997, 1996 and 1995, respectively.

Future minimum lease payments required under these agreements are as follows for
 the years ending December 31:

                           1998     $2,232
                           1999      1,709
                           2000      1,080
                           2001        878
                           2002        233
                                       ---
                                    $6,132

Royalty Agreements

         The  Company  currently  has  cross-license   agreements  with  certain
industry competitors. Under these agreements,  royalties are paid by the Company
on sales of certain  licensed  products.  Royalty expense under these agreements
was included in selling,  general and  administrative  expense in 1997, 1996 and
1995.

Legal Matters

         The automatic identification and data capture industry is characterized
by  substantial  litigation  regarding  patent and other  intellectual  property
rights.  There is litigation pending in the United States District Court for the
Western  District of New York between the Company and one of its  customers,  on
the one hand, and Symbol  Technologies,  Inc.  (Symbol) on the other,  involving
certain of Symbol's  patents.  In that  action,  the  Company  has also  alleged
violation of the  antitrust  laws and unfair  practices by Symbol and Symbol has
alleged breaches of certain license  agreements  between the Company and Symbol,
including  claims  that  royalties  have been  underpaid.  The  Company has also
assumed the responsibility of defending the action on behalf of its customer and
has provided certain rights of indemnification to its
<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

customer.  The Company  intends to defend  itself and its  customer  vigorously.
Although the Company  maintains  that  Symbol's  patents are  invalid,  that the
Company has not infringed the patents, or both, and that the Company has not, as
was alleged, breached the Symbol license, nor underpaid royalties,  there can be
no  assurance  that this or any other  action  will be decided or settled in the
Company's  favor.  There can be no assurance  that others will not assert claims
against the Company that result in litigation.  Any such litigation could result
in significant expense,  adversely impact the Company's marketing,  give rise to
certain  indemnity  rights on the part of  customers  and divert  the  Company's
attention  from other  matters.  If any of the Company's  products were found to
infringe a third-party  patent,  the third party could be entitled to injunctive
relief,  which  would  prevent  the Company  from  selling  any such  infringing
products.  In addition,  the Company could be required to pay monetary  damages.
Although  the  Company  could  seek a license  to sell  products  determined  to
infringe a third-party patent, there can be no assurance that a license would be
available on terms acceptable to the Company.  The Company could also attempt to
redesign  any  infringing  products so as to avoid  infringement,  although  any
effort  to do so  could  be  costly  and  time-consuming,  and  there  can be no
assurance the effort would be successful.

11. SHAREHOLDERS' EQUITY

         In September 1997, the Company  completed a private placement of equity
with Hydra Investissements S.A., a Luxembourg  Corporation (the Purchaser).  The
Company  issued  110  shares  of  Series A  Convertible  Preferred  Shares  (the
Preferred  Shares) which are convertible  into 1.375 million Common Shares.  The
Preferred  Shares are  convertible  at anytime at the option of the holders into
Common Shares of the Company.  The conversion price is $8.00 per Common Share or
one Preferred  Share for 12.5 Common Shares.  In connection with the issuance of
Preferred Shares, a warrant evidencing the right to purchase an aggregate of 180
Common  Shares of the Company was issued to the  Purchaser.  This warrant has an
exercise  price of $8.00 per  share and may be  exercised  at  anytime  prior to
September 10, 2001. As a result,  the Purchaser  beneficially owns 1.555 million
Common Shares of the Company.  The net proceeds to the Company from the offering
were $10.2 million.  The Company used the proceeds for working capital  purposes
and to repay a portion of its senior revolving credit facility.

         In March 1995, the Company  completed a secondary stock  offering.  The
Company sold  approximately  2.3 million  shares at a price of $11.00 per share.
The net  proceeds to the Company  from the  offering  were  approximately  $23.6
million.  The Company used  approximately  $7.2 million of the net proceeds from
the offering to repay in full the outstanding  indebtedness  under the Company's
construction  loan  used to  finance  its new  headquarters,  manufacturing  and
engineering  facility.  The Company also used  approximately $6.8 million of the
net  proceeds  from the offering to repay in full the  outstanding  indebtedness
under  the  Company's  term  loan  that was used to  finance  a  portion  of its
acquisition of LazerData Corporation in December 1994.

Shareholder Rights Plan

         In December  1997,  the Company  adopted a  Shareholder  Rights Plan in
which one  Preferred  Share  Purchase  Right (the  Right) was  granted  for each
outstanding  Common Share.  The Rights are exercisable only if a person or group
acquires or tenders an offer that would  result in the  beneficial  ownership of
20% or more of the then  outstanding  Common  Shares of the Company.  Each Right
entitles the holder to
<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

purchase  one  one-thousandth  of a share of the  Company's  Series B  Preferred
Shares at a purchase price of $45. Under certain  circumstances,  the Rights are
redeemable  at a price of $0.01 per Right and,  unless  redeemed  earlier,  will
expire in December 2007. There were no issued or outstanding  Series B Preferred
Shares at December 31, 1997.

Stock Option Plans

         Options under the Company's Stock Option Plans (the SOP) may be granted
to  employees,  consultants,  directors  and  officers and may vest over time or
based upon the performance of the Company's stock, or both, at the discretion of
the Board of  Directors.  Options  must be issued at an exercise  price not less
than fair  market  value on date of grant and expire five to ten years from date
of grant unless employment is terminated or death occurs earlier.

         In  accordance  with the  provisions  of the SOP,  the Company may make
loans to  participants  to finance the exercise  price and related  income taxes
upon  the  exercise  of an  option.  During  1997,  the  Company  received  loan
repayments from participants totaling $278. During 1996, the Company granted two
loans to the Chairman and Chief Executive Officer, totaling $382. Each loan is a
five-year  loan at an  interest  rate of  9.50%  and is  secured  by the  shares
purchased with the proceeds of the loan. During 1995, the Company granted a loan
to the Chairman and Chief Executive  Officer and a loan to a member of the Board
of Directors of the Company,  totaling $593. Each loan is a five-year loan at an
interest rate of 7.34% and is secured by the shares  purchased with the proceeds
of the loan.

The Company  accounts for its SOP and  Employee  Stock  Purchase  Plan under APB
Opinion  No. 25,  "Accounting  for Stock  Issued to  Employees,"  under which no
compensation  cost was  recognized.  In October  1995,  Statement  of  Financial
Accounting  Standards  No.  123  (SFAS No.  123),  "Accounting  for  Stock-Based
Compensation,"  was issued.  This  statement  encourages,  but does not require,
companies to use the fair value based method to measure compensation cost, which
is then  recognized over the service period  (usually the vesting  period).  The
Company continues to measure  compensation cost using the intrinsic value method
as prescribed by APB Opinion No. 25. Had compensation  cost for these plans been
determined based on the fair value at the grant dates for awards consistent with
SFAS No. 123, the  Company's  pro forma  amounts for net income and earnings per
share would have been as follows:

                                             1997        1996        1995
                                             ----        ----        ----
Net income/(loss) as reported ............  $2,889    $(46,980)     $5,449
Net income/(loss) pro forma ..............  $2,175    $(48,501)     $5,325
Net income/(loss) per common and common
    equivalent share as reported:
    Basic ................................   $0.26     $(4.48)      $0.58
    Diluted ..............................   $0.24     $(4.48)      $0.54
Net income/(loss) per common and
    common equivalent share pro forma:
    Basic ................................   $0.19     $(4.62)      $0.57
    Diluted ..............................   $0.18     $(4.62)      $0.53
<PAGE>



                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)


         SFAS No.  123 has only been  applied to options  granted  and  Employee
Stock Purchase Plan purchases after January 1, 1995. As a result,  the pro forma
compensation  expense may not be representative of that to be expected in future
years.

         The fair value of each option  grant is  estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1997, 1996 and 1995:

                              1997              1996              1995
                              ----              ----              ----
Risk free interest rate       6.19%            5.95%              6.66%
Expected dividend yield        0%                  0%              0%
Expected lives               4 years          4 years            4 years
Expected volatility            45%              45%                45%
Fair value of options granted $2.89            $3.31              $5.45

The  following is a summary of the activity in the  Company's  SOP for the years
ended December 31:

<TABLE>
<CAPTION>

                                                        1997                        1996                       1995
                                               ------------------------    -----------------------    ------------------------
                                                            Weighted                    Weighted                   Weighted
                                                            Average                     Average                    Average
                                                Shares       Price          Shares       Price         Shares       Price
                                               ----------   --------       ----------   ---------     ----------   --------
<S>                                                <C>       <C>               <C>       <C>              <C>       <C>
Options outstanding at beginning of
   period ..................................       2,818     $8.33             2,138     $8.41            2,299     $8.02
Options granted ............................       1,094      6.98               953     7.78               105     12.54
Options exercised ..........................       (162)      7.51             (173)     6.27             (200)      6.52
Options forfeited/canceled .................       (704)      9.00             (100)     8.06              (66)      6.84
                                               ----------                  ----------
                                                                                                      ==========
Options outstanding at end of period .......       3,046     $7.76             2,818     $8.33            2,138     $8.41
                                               ==========                  ==========                 ==========
Number of options at end of period:
   Exercisable .............................       1,884                       1,630                      1,575
   Available for grant .....................         394                         784                      1,637

</TABLE>

         The Company was able to realize an income tax benefit in 1997, 1996 and
1995 from the exercise or early  disposition  of stock  options.  For  financial
reporting purposes,  this benefit resulted in a decrease in current income taxes
payable and an increase in additional paid-in capital.

Warrants

         In  connection  with  the  issuance  of  Preferred  Shares,  a  warrant
evidencing  rights to purchase an aggregate of 180 Common  Shares of the Company
were issued and sold to the Purchaser of the Preferred Shares.  This warrant has
an exercise price of $8.00 per share and may be exercised prior to September 10,
2001.

<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

The acquisition of Spectra was financed, in part, by the subordinated term loan.
In connection with the subordinated  term loan,  warrants  evidencing  rights to
purchase an aggregate  of 975 Common  Shares of the Company were issued and sold
to the purchasers of the subordinated term loan. These warrants have an exercise
price of $8.00 per share and may be exercised at anytime prior to July 12, 2006.

         The  holders  of  these  warrants  have  certain  rights   relating  to
registration and to the repurchase by the Company of the warrants and the shares
issued upon the exercise of the warrants under certain circumstances.

Employee Stock Purchase Plan

         The Company has an Employee  Stock Purchase Plan (the Plan) under which
250 Common Shares can be issued. Under the terms of the Plan, eligible employees
may purchase the Company's Common Shares semi-annually on approximately  January
1 and July 1 through payroll deductions.  The purchase price is the lower of 85%
of the fair  market  value of the  shares  on the  first or last day of each six
month offering period. Employees purchased approximately 67 shares at an average
price of $5.81 per share, 26 shares at an average price of $7.82 per share and 9
shares  at an  average  price of $9.16  per share  during  1997,  1996 and 1995,
respectively. The Plan expires on December 31, 2000.

         The fair value of the purchase  rights is estimated on the first day of
the  offering  period  using the  Black-Scholes  option  pricing  model with the
following weighted average assumptions for grants in 1997, 1996 and 1995:

                                         1997      1996        1995
                                         ----      ----        ----
Risk free interest rate                  5.12%     5.89%       6.10%
Expected dividend yield                     0%        0%        0%
Expected lives                          6 mos.    6 mos.      6 mos.
Expected volatility                        45%        45%       45%
Fair value of purchase rights granted    $2.06     $2.54       $3.78

12. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE

<TABLE>
<CAPTION>


                                                       Year Ended December 31, 1997
                                       --------------------------------------------------------------
                                              Income               Shares               Per-Share
                                            (Numerator)         (Denominator)            Amount
                                       ----------------    ------------------     ----------------
<S>                                           <C>                  <C>                    <C>
Basic EPS
Income available to
  common shareholders                         $2,889               11,197                 $0.26
                                                                                     ================
Effect of dilutive securities:
   Options                                      --                      29
   Warrants                                     --                     422
   Preferred shares                             --                     195
                                          ----------------    ------------------
Diluted EPS
Income available to common
  shareholders and assumed conversions        $2,889               11,843                 $0.24
                                          ================    ==================     ================

</TABLE>

<PAGE>

                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

<TABLE>
<CAPTION>

                                                               Year Ended December 31, 1996
                                               --------------------------------------------------------------
                                                      Income                Shares              Per-Share
                                                    (Numerator)         (Denominator)             Amount
                                                  ----------------    -------------------     ---------------

<S>                                                  <C>                    <C>                  <C>
Basic EPS
 Income available to
   common shareholders ......................        $(46,980)              10,490               $(4.48)
                                                  ================    ===================     ===============
 Diluted EPS
 Income available to common
   shareholders and assumed conversions .....        $(46,980)              10,490               $(4.48)
                                                  ================    ===================     ===============


                                                              Year Ended December 31, 1995
                                              --------------------------------------------------------------
                                                     Income                Shares              Per-Share
                                                   (Numerator)          (Denominator)            Amount
                                                 ----------------     ------------------     ---------------
Basic EPS
Income available to
  common shareholders .......................        $5,449                 9,329                $0.58
                                                                                             ===============
Effect of dilutive securities:
   Options ..................................          --                     684
                                                 ----------------     ------------------
Diluted EPS
Income available to common
  shareholders and assumed conversions ......        $5,449                10,013                $0.54
                                                 ================     ==================     ===============
</TABLE>


         Basic EPS were  computed by dividing  reported  earnings  available  to
common  shareholders  by weighted  average shares  outstanding  during the year.
Diluted  EPS for the  years  1997  and 1996  were  determined  on the  following
assumptions:  1) warrants  issued in  connection  with the private  placement of
equity were converted upon issuance on September 10, 1997, 2) warrants issued in
connection  with the  acquisition of Spectra were converted on July 12, 1996 and
January 1, 1997 and 3) Preferred Shares were converted on September 10, 1997.

         Options to purchase 1,148,  2,495,  and 151 Common Shares at an average
price of $9.52, $9.70 and $12.72 per share were outstanding for the years ending
December 31, 1997,  1996, and 1995,  respectively,  but were not included in the
computation  of diluted EPS since the options'  exercise  price was greater than
the average market price of Common Shares.

         The  Company is required  to adopt SFAS No. 128  retroactively  for all
periods presented.  The effect of this accounting change on previously  reported
EPS data was as follows:

                                            1996                 1995
                                       ----------------     ----------------
Primary EPS as reported                    $(4.48)               $0.54
Effect of SFAS No. 128 ............             --                0.04
                                       ----------------     ----------------
Basic EPS as restated .............        $(4.48)               $0.58
                                       ================     ================


<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

13.  401(K) PLANS

         During  1997,  the  former  Spectra  401(k)  plan was  merged  into the
Company's 401(k) plan. The plan is available to U.S.  employees  meeting certain
service  and  eligibility  requirements.  The  Company  pays a monthly  matching
contribution equal to 50% of the employees'  contributions up to a maximum of 6%
of their eligible  compensation.  Plan expense was $717, $377 and $193 for 1997,
1996 and 1995, respectively.

14.   SEVERANCE AND OTHER COSTS

         During the  second  quarter of 1997,  the  Company  recorded a one-time
pretax  charge of $5.2  million  for  severance  and other  costs.  Of the total
charge,  approximately $2.3 million was associated with the Severance  Agreement
with the former CEO,  $1.2 million was for employee  severance and benefit costs
for the  elimination  of  approximately  30 positions  including  several senior
executives,  a $1.0  million  inventory  write-off  for the  discontinuation  of
certain  products,  and $0.7  million for the  centralization  of  research  and
development efforts and the relocation of manufacturing of certain product lines
between its two manufacturing facilities.

15. ACQUISITION RELATED RESTRUCTURING AND OTHER COSTS

         During the third  quarter of 1996,  the  Company  recorded a  one-time,
pretax  charge  of $10.0  million  for the cost of  restructuring  its  existing
operations  with those of Spectra  which was acquired in July 1996. Of the total
restructuring charge, approximately $5.0 million was associated with the closing
of the Company's Sanford,  Florida  manufacturing  facility and relocating those
operations to its Webster,  New York  facility,  $3.6 million was related to the
write-off of previously existing intangible and tangible assets and $1.4 million
was recorded for employee  severance  and benefit costs for the  elimination  of
seven  positions.  As of  December  31,  1997,  all  positions  targeted  in the
restructuring program were eliminated.  Restructuring actions are expected to be
completed by the end of 1998. The Company  recorded  charges against the accrual
of  $3.7  million  and  $5.3  million  in  1997  and  1996,  respectively.   The
restructuring  accrual as of December  31, 1997 was  approximately  $1.0 million
which  relates  to  current   contractual   obligations.   There  have  been  no
reallocations or reestimates to date.

         In addition,  in the third quarter of 1996, the Company allocated $60.1
million of the  Spectra  purchase  price to  acquired  in-process  research  and
development  projects,  which  represents  the estimated  fair values related to
these  projects  determined  by  an  independent  appraisal.   Proven  valuation
procedures and techniques  were utilized in determining the fair market value of
each intangible asset. The development  technologies were evaluated to determine
that there were no  alternative  future  uses.  Such  evaluation  consisted of a
specific review of the efforts, including the overall objectives of the project,
progress  toward the  objectives  and  uniqueness of  developments  toward these
objectives.  To bring these projects to fruition, high risk developmental issues
need to be  resolved  which  will  require  substantial  additional  effort  and
testing. Therefore,  technological feasibility of these new products has not yet
been achieved. As these projects have not reached technological  feasibility and
alternative  future  use of these  developmental  technologies,  apart  from the
objectives of the individual projects, does not exist, these costs were expensed
as of the acquisition  date. The  acquisition  related  restructuring  and other
costs reduced 1996 income before income taxes, net income, basic EPS and diluted
EPS by $70.1 million, $44.2 million, $4.21 and $4.21, respectively.



<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

16.  DISCONTINUED OPERATIONS

         In June 1997, the Company disposed of its TxCOM  subsidiary,  which was
acquired  as part of the  Spectra  acquisition.  For 1997 and 1996,  results  of
operations  were  reported  as  discontinued   operations  in  the  Consolidated
Statements  of  Operations.  The Company  recognized a net gain on operations of
$164 in 1997 and a net loss on  operations  of $229 in 1996.  Disposal of TxCOM,
which  occurred in June 1997,  resulted in the  recording  of losses of $265 and
$5,217 in 1997 and 1996,  respectively.  These losses  include the write-down of
the  assets to their net  realizable  value  and the costs of  disposing  of the
subsidiary, net of applicable tax benefits.

17.  SIGNIFICANT CUSTOMER INFORMATION

         The  Company  sells its  products  principally  to  original  equipment
manufacturers,  value-added  resellers,  distributors  and systems  integrators.
During 1997 and 1996, no individual  customer  accounted for greater than 10% of
net sales.  During 1995, net sales to the Company's  largest customer  accounted
for approximately  17%. No other customers were responsible for greater than 10%
of net sales in 1995.  The  Company's  arrangements  with  major  customers  are
generally nonexclusive.


<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data


18.  SELECTED QUARTERLY FINANCIAL DATA:  (UNAUDITED)

<TABLE>
<CAPTION>
                                                             First        Second         Third         Fourth
                                                            Quarter       Quarter       Quarter        Quarter
                                                           ----------    ----------    -----------   ------------
Year Ended December 31, 1997
----------------------------
<S>                                                          <C>           <C>            <C>            <C>
Net sales .............................................      $54,236       $47,301        $53,191        $53,112
Gross profit ..........................................       22,701        17,913         22,167         22,064
Income (loss) from continuing
    operations ........................................          886       (3,246)          2,542          2,808
Loss from discontinued operations .....................         (16)          (85)             --             --
Net income (loss) .....................................          870       (3,331)          2,542          2,808

Net  income (loss) per common
    and common equivalent share:
Basic:
   Continuing operations ..............................        $0.08       $(0.29)          $0.23          $0.25
   Discontinued operations ............................           --        (0.01)             --             --
                                                           ----------    ----------    -----------   ------------
   Net income (loss) ..................................        $0.08       $(0.30)          $0.23          $0.25
                                                           ==========    ==========    ===========   ============
Diluted:
   Continuing operations ..............................        $0.08       $(0.29)          $0.22          $0.20
   Discontinued operations ............................           --        (0.01)             --             --
                                                           ==========    ==========    ===========   ============
   Net income (loss) ..................................        $0.08       $(0.30)          $0.22          $0.20
                                                           ==========    ==========    ===========   ============

Year Ended December 31, 1996
----------------------------
Net sales .............................................      $21,499       $22,052        $46,486        $56,014
Gross profit ..........................................        9,156         8,564         20,283         24,373
Income (loss) from continuing
    operations ........................................          435           211       (43,444)          1,264
Loss from discontinued operations .....................           --            --        (5,331)          (115)
Net income (loss) .....................................          435           211       (48,775)          1,149

Net  income (loss) per common
   and common equivalent share:
Basic:
   Continuing operations ..............................        $0.04         $0.02        $(3.99)         $0.11
   Discontinued operations ............................           --            --         (0.49)         (0.01)
                                                           ----------    ----------    -----------   ------------
   Net income (loss) ..................................        $0.04         $0.02        $(4.48)         $0.10
                                                           ==========    ==========    ===========   ============
Diluted:
   Continuing operations ..............................        $0.04         $0.02        $(3.99)          $0.11
   Discontinued operations ............................           --            --         (0.49)         (0.01)
                                                           ==========    ==========    ===========   ============
   Net income (loss) ..................................        $0.04         $0.02        $(4.48)          $0.10
                                                           ==========    ==========    ===========   ============

</TABLE>


<PAGE>


                            PSC INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1997
                (All amounts in thousands, except per share data)

19.  OPERATIONS BY GEOGRAPHIC AREA

         The  Company is  engaged  in one  industry,  specifically  the  design,
manufacture  and  marketing  of handheld and fixed  position  bar code  readers,
verifiers,  integrated sortation and point-of-sale scanning systems.  Operations
in this business  segment are summarized below by geographic area. The Company's
operations  in  Europe  and the Rest of the World  (ROW)  primarily  consist  of
selling and  performing  field  service  maintenance  on products  designed  and
manufactured in the United States.

         In  determining  earnings  before  provision  for income taxes for each
geographic  area,  sales and purchases  between areas have been accounted for on
the basis of internal transfer prices set by the Company. Certain U.S. operating
expenses are allocated  between  geographic  areas based upon the  percentage of
geographic area revenue to total revenue.

         Identifiable  assets are those tangible and  intangible  assets used in
operations in each geographic area.



<TABLE>
<CAPTION>

   Year Ended December 31, 1997             North
                                           America             Europe              ROW           Eliminations           Total
                                        ---------------    ---------------    --------------    ----------------    ---------------
<S>                                           <C>                 <C>               <C>                       <C>
    Sales to unaffiliated
       customers .....................        $120,606            $57,518           $29,716                   $           $207,840
                                                                                                             --
    Transfers between
       geographic areas ..............          39,820                157                --            (39,977)                 --
                                        ---------------    ---------------    --------------    ----------------    ---------------
    Total net sales ..................         160,426             57,675            29,716            (39,977)            207,840
                                        ===============    ===============    ==============    ================    ===============
    Earnings before provision
       for income taxes ..............           2,333              1,284             1,134                  --              4,751
                                        ===============    ===============    ==============    ================    ===============
    Identifiable assets ..............        $187,943            $17,996           $ 3,730           $(36,871)           $172,798
                                        ===============    ===============    ==============    ================    ===============


Year Ended December 31, 1996                  North
                                             America            Europe              ROW           Eliminations           Total
                                          ---------------    --------------    --------------    ----------------    --------------
Sales to unaffiliated
   customers .........................          $ 96,321           $31,968           $17,762       $          --          $146,051
Transfers between
   geographic areas ..................            18,165                --                --            (18,165)                --
                                          ---------------    --------------    --------------    ----------------    --------------
Total net sales ......................           114,486            31,968            17,762            (18,165)           146,051
                                          ===============    ==============    ==============    ================    ==============
Earnings before provision
   for income taxes ..................          (49,843)           (3,102)          (12,982)                  --          (65,927)
                                          ===============    ==============    ==============    ================    ==============
Identifiable assets ..................          $204,414           $12,962           $ 4,196           $(38,211)          $183,361
                                          ===============    ==============    ==============    ================    ==============


Year Ended December 31, 1995                  North
                                             America           Europe              ROW            Eliminations          Total
                                          --------------    --------------    ---------------    ---------------    ---------------
Sales to unaffiliated
   customers .........................          $70,189           $10,996             $6,331        $        --            $87,516
Transfers between
    geographic areas .................            1,861                --                 --            (1,861)                 --
                                          --------------    --------------    ---------------    ---------------    ---------------
Total net sales ......................           72,050            10,996              6,331            (1,861)             87,516
                                          ==============    ==============    ===============    ===============    ===============
Earnings before provision
   for income taxes ..................            5,837             2,295                563                 --              8,695
                                          ==============    ==============    ===============    ===============    ===============
Identifiable assets ..................          $69,006           $ 2,231           $      -         $       --            $71,237
                                          ==============    ==============    ===============    ===============    ===============
</TABLE>
<PAGE>



                                   SCHEDULE II

                            PSC INC. AND SUBSIDIARIES

                        VALUATION AND QUALIFYING ACCOUNTS

              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

                           (All amounts in thousands)

<TABLE>
<CAPTION>

                                            1997                 1996                 1995
                                       ----------------     ----------------     ----------------
<S>                                        <C>                   <C>                  <C>
Accounts Receivable Reserve-
BALANCE, at beginning of year              $1,101                $387                 $576
  Provision for doubtful accounts            346                  168                 (134)
  Write-offs of doubtful accounts,
     net of recoveries                      (278)                (200)                (55)
  Other                                      --                 746 (1)                --
                                       ================     ================     ================
BALANCE, at end of year                    $1,169               $1,101                $387
                                       ================     ================     ================

</TABLE>

(1) Amount represents the reserve recorded in connection with the acquisition of
Spectra.