SCAN OPTICS INC, 10-K, 1996-03-29

SCAN OPTICS INC
10-K, 1996-03-29
COMPUTER PERIPHERAL EQUIPMENT, NEC

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

FORM 10-K
(Mark One)
(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1995

( )Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to

Commission File No. 0-5265

SCAN-OPTICS, INC.
(Exact name of registrant as specified in its charter)

Delaware 06-0851857

(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)

22 Prestige Park Circle, East Hartford, CT 06108
(Address of principal executive offices) Zip Code

(860) 289-6001
(Registrant's telephone number, including area code)

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

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

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

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

The aggregate market value of the voting stock (common) held by non-affiliates
of the registrant: $24,288,078 as of March 27, 1996.

The number of shares of common stock, $.02 par value, outstanding as of March
27, 1996 was 6,939,451.

<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement, relating to the 1996 Annual Meeting
of Stockholders, which will be filed pursuant to Regulation 14A with the
Securities and Exchange Commission not later than 120 days after the end of the
fiscal year, are incorporated by reference and included in the following:

Part III-Item 10 - Directors and Executive Officers of the Registrant
Part III-Item 11 - Executive Compensation
Part III-Item 12 - Security Ownership of Certain Beneficial
Owners and Management
Part III-Item 13 - Certain Relationships and Related Transactions
<PAGE>

PART I

ITEM 1 - BUSINESS

Scan-Optics, Inc. (the Company) was incorporated in Delaware in 1968 and has
its principal office at 22 Prestige Park Circle, East Hartford, Connecticut
06108.

The Company designs, manufactures, markets and services information processing
systems which are used for imaging, data capture, document processing and the
management of information. The Company's Series 7000 Network Image Scanners and
Series 9000 optical character recognition/(OCR) and intelligent character
recognition (ICR) scanners deliver cost-effective, high volume imaging
solutions. Its UNIX and PC-based post-scanning systems offer verification,
image storage and retrieval, and document management in an open-systems
environment. The Company's professional services integrate scanning platforms
and networked tools to deliver a turn-key system solutions.

TARGET SOLUTIONS

HEALTH CARE AND INSURANCE PROCESSING
The Company has been providing health care related information systems since
1985. These applications include processing customer satisfaction forms,
patient encounter forms, and Health Care Financing Administration (HCFA)
Forms. To ease the implementation for customers, the systems are designed to
utilize industry standard components wherever feasible, including processing on
industry standard client/server, open LAN-based systems designed specifically
to improve the efficiency of health claim form reporting and processing. The
Company's goal in providing this service is to minimize the customer investment
involved with processing paper health claim forms.

ORDER PROCESSING
The Company has been providing applications for order entry for at least 16
years. At one customer site, order entry software is processing over 800,000
orders on a daily basis. Order entry is a key operational requirement for any
successful company. The Company's systems fulfill this requirement in an
efficient, timely, and cost-effective manner. The Company enjoys the
reputation as a leading supplier of high speed order entry software.

TAX AND FINANCIAL SERVICES PROCESSING
The Company has had significant experience in processing taxes at various state
governments as well as at the Internal Revenue Service. The Company's Series
9000 systems recently processed the One Hundred Millionth (100,000,000th) tax
document on the IRS SCRIPS System during this past calendar year. These Series
9000 systems use application programs developed and supported by the Company.
The Company has 25 years of experience in tax processing.

PRODUCTS

The Company designs, manufactures, markets and services information processing
systems which use "state of art" technology for imaging, automated data
capture, document processing and the management of information. These systems
employ high speed paper movement, OCR/ICR, high speed image capture, image
storage and retrieval systems, image information processing, key-entry,
microfilming, ink jet printing, high-speed paper handling with multi-pocket
page and/or document sorting, local area networking, client/server PC
processing, communications software and software/hardware integration
technologies to assure a complete approach to engineering solutions for data
processing.

These key product disciplines translate integration skills that leverage the
core competencies of the Company to provide broader solution alternatives.
These core competencies include:

Document Scanning
Character Recognition (OCR, ICR, Barcode, Marksense, etc.)
High Speed Paper Handling
Image Enhancement Algorithms and Image Quality
Key-From-Image and Data Entry
Customer Relations
Value Added Engineering Services and Solutions

CORE COMPETENCIES

DOCUMENT SCANNING
The Company has been addressing the high-speed, high-volume, page/document
processing market place since its inception in 1968. During 1992, the Company
introduced the newest generation of scanners called the Series 9000 system.
This system launched the Company into the full page image and recognition (ICR)
market. Full page document processing includes front and back imaging, OCR
reading, serialization and microfilming of a document in a single pass.
During 1994, the Company introduced the Model 7800 scanner which is an image
product which can be utilized to improve Customer Service, Order Processing,
and Microfilm Replacement.

CHARACTER RECOGNITION
As with the scanners, the Company has been providing its own developed
character recognition since 1968. This recognition has always included the
basic in-line recognition of machine printed, handprinted, and mark sense.
With the introduction of the Series 9000 system, the Company has expanded this
recognition to include barcode, patch code, special educational score testing
analysis, and special stamp recognition. In addition to these recognition
processes, the Company has integrated and developed neural recognition
technologies that support both in-line and post recognition.

HIGH SPEED PAPER HANDLING
The Company is a leader in patented high speed paper handling systems. The
Series 9000 scanner which was introduced in 1992 has over 100 systems installed
world wide. The Company has over 300 scanning systems installed world wide
processing 15 million pieces of paper on a daily basis.

IMAGE ENHANCEMENT ALGORITHMS AND IMAGE QUALITY
Image enhancement algorithms and image quality are priority development
activities for the Company. Image enhancement starts at the scanner capture
system. The Company provides the fastest page capture and image system
on the market today. This processing is carried forward into the Company's
key-From-Image and Image Storage and Retrieval Systems. Management believes
that the Company's image quality is among the best in the industry
.
Electronic image processing and storage are rapidly overtaking the use of
microfilm and the Company is on the leading edge of this technology with
its hardware and application software solutions.

KEY-FROM-IMAGE AND DATA ENTRY
The Company has been providing complete hardware and software solutions using
Key-From-Image (KFI) and Data Entry since 1976. This KFI and Data Entry
solution remains important today, using the latest open network and platform
designs with Windows<trademark>, UNIX, Novell, TCP/IP, NT, and other industry
standard components. By combining the high-speed scanning systems with the
flexibility of KFI and Data Entry, customers are able to lower their overall
data capture and document processing costs while improving the level of data
accuracy.

CUSTOMER RELATIONS
28 Years of Customized Software Solutions
Customized software support has provided service to the Company's customers
since 1968. The Company's scanners and assorted network system products
provide the hardware platforms for delivering advanced high-volume forms
processing, imaging, and document management system solutions, especially in
Health Care, Order Entry, and Tax Processing. This customized software
support enables the Company to provide full production-ready application
systems tailored to the customer's specific needs.

This support is provided through professional services offered by the Company.
These services offer a total package of Application Services including:
specifications, design, development, installation, training, support and
project management. The Company also provides individual, custom software
services as requested by the customer. In this way, the Company can either
provide the entire package of software support or simply provide those services
that the customer desires.

28 Years of Hardware Support
The Company has been offering service and maintenance support to its broad
customer base since 1968. This support is available with either leased or
purchased systems in both the domestic and the international markets. Service
is provided through a network of over 100 service centers in North America and
the United Kingdom. The Company provides on-site and on-call service with
response times of two hours or less. The Company focuses on comprehensive
diagnostic routines, modular design and preventative maintenance procedures to
assure its users of high system availability to perform mission critical
applications.

Service revenue accounted for 34%, 36% and 37% of the Company's total revenue
for 1995, 1994 and 1993, respectively.

VALUE ENGINEERING SERVICES AND SOLUTIONS
The Company has been supplying engineering services and solutions to meet
customer needs since introducing its first fully integrated solution in 1976.
The solutions include scanning, recognition, Key-From-Image, data entry, and
communications. During 1993, the Company was selected to develop a prototype
system to process medical claims for a health care agency in Japan. This
system was designed with 36 stacker pockets for sorting forms; expanded paper
handling capabilities for light-weight, flimsy forms; high resolution image
cameras to permit recognition of complex Japanese kanji characters; and
software forms recognition for up to 20,000 different form formats.

The Company has been involved in special recognition techniques to process
order forms that contain stamps. These stamps are used as an entry into a
sweepstake contest or to select ordered items for a record or book club. The
stamps are of a multitude of colors and are successfully processed through the
Company's special recognition features. In addition to stamp processing, the
Company has been engaged in recognition analysis for educational test scoring.
This process is accomplished in full duplex mode at a transport speed of 50
inches per second.

SIGNIFICANT CUSTOMERS

In 1995, one customer accounted for approximately 31% of consolidated revenues.
Two customers accounted for approximately 22% of consolidated revenues in 1994,
each at 11%. No single customer accounted for more than 10% of consolidated
revenues in 1993.

CHANNELS OF DISTRIBUTION

The Company is augmenting its practice of selling directly to end-users and
distributors to respond to new opportunities in the marketplace. The focus on
providing more complete solutions to customers has stimulated the pooling of
resources with selected system integration firms and specialized niche
suppliers. The cooperative effort with system integrators and other vendors
has introduced the Scan-Optics logo to new markets in 1995, both domestically
and internationally.

BACKLOG

The backlog for the Company's products and services as of December 31, 1995
and 1994 was approximately $12,483,000 and $19,775,000 respectively. The
backlog consists of equipment, software and services to be sold and
noncancelable rentals and maintenance due on existing rental and maintenance
contracts. The Company normally delivers a system within 30 to 180 days
after receiving an order, depending upon the degree of software customization
required.

MANUFACTURING

Manufacture of the Company's products requires the fabrication of sheet metal
and mechanical parts, the subassembly of electronic and mechanical parts and
components, and operational and quality control testing of components,
assemblies and completed systems. The Company's products consist of both
standard and Company-specified mechanical and electronic parts, sub-
assemblies and major components, including microcomputers. Most parts are
purchased, including many complex electronic and mechanical sub-assemblies.
The Company also purchases major standard components, including magnetic tape
and disk storage drives, display terminals, and microcomputers. An important
aspect of the Company's manufacturing activities is its quality control program
which uses computer-controlled testing equipment.

The Company has not experienced significant shortages of any components or
subassemblies; however, alternate sources for such components and subassemblies
have been developed.

COMPETITION

The Company competes with service providers utilizing multiple vendor
architectures. The Company differentiates its solutions by offering a total
system, including post installation of hardware and software services. The
Company focuses on industry specific "application" areas with solutions
utilizing image and data entry/data capture systems provided by the Company.

PATENTS

The Company currently has five United States patents in force which expire
between 2003 and 2013. The patents are on mechanical systems, electronic
circuits, electronic systems and software algorithms which are used throughout
the product lines. The Company expects to continue to apply for patents on its
new technological developments when it believes they are significant.

EMPLOYEES

As of December 31, 1995 the Company employed 269 persons, including 20 with
administrative and support responsibilities, 144 in marketing, sales, software
and service activities and 105 in engineering and production capacities. The
Company considers its employee relations to be good. The Company has not
experienced any work stoppages.

PRODUCT DEVELOPMENT

In June 1992, the Company introduced the Series 9000 Scanner. The Series 9000
integrates the latest in character recognition, image capture, and paper
handling technology into a high speed scanner. During 1993, the Company
introduced several options for this scanner. These options permit character
recognition and image processing on the "reverse side" of documents; a special
small document stacker module; and the ability to recognize several industry
standard bar-codes.

The Series 9000 interfaces with other company products to provide multi-media
data entry and image storage retrieval. During 1994, the Company developed and
delivered a network-based scanning, recognition and data entry product - the
Series 7000 - which addresses requirements for a distributed solution.

In April 1995, the Company introduced the Model 7800 Scanner. The Model 7800
is the world's fastest full-page image scanner, capable of capturing up to 200
full size pages per minute. It is based on Scan-Optics' high-end, industry
proven Series 9000.

The Company considers product development to be a significant element in
maintaining market share. During the years ended December 31, 1995, 1994 and
1993, the Company's research and development expenses were $4,574,000,
$5,690,000, and $4,601,000, respectively. Some portion of these amounts were
funded under the development agreements described above.

The Company intends to continue its program of development of additional
options and capabilities for its existing products as well as the development
of new products which exploit the Company's core competencies: document
scanning, character recognition, high speed paper handling, image enhancement,
key-from-image and data entry, customer relations and value engineering
services and solutions.

FUNDED DEVELOPMENT AGREEMENTS

During 1990, the Company entered into two separate agreements for the
development of new product technology, which provided a total funding of
$3,645,000 over an eighteen month period. Revenues related to these
development projects were recorded through 1992, which offset related
costs incurred to successfully develop the products. The agreements provide
the respective third party with exclusive rights to market the developed
product in its geographic market area while the Company will manufacture the
product and retain ownership and all other distribution rights. Royalties and
other considerations, up to a maximum of 130% of the amount advanced to the
Company, are required to be paid based on sales of the new product technology
through the termination dates of the agreements, June 30, 1995 and December 31,
1996. As of December 31, 1995, the Company had repaid or accrued $4,432,000 or
90% of the maximum potential royalty.

During 1993, the Company entered into a $1,160,000 product development
agreement for a specific customer, which required various modifications and
enhancements to the Company's Series 9000 product. The Company recorded
revenue related to this development agreement of $370,000 in 1994 and $790,000
in 1993. These revenues offset related costs incurred to develop the
modifications and enhancements. Two prototype systems were delivered in the
first quarter of 1994 and successfully passed customer acceptance testing. An
initial production contract was awarded for delivery in the fourth quarter of
1994. The ownership of the technologies created as a result of this
development agreement remains with the Company. No royalties or other
considerations are required as a part of this agreement.

During 1995, the Company entered into $700,000 of product development
agreements with a specific customer, which required various modifications and
enhancements to the Company's Series 9000 product. The Company recorded
revenue related to these development agreements of $336,000 in 1995. These
revenues offset related costs incurred to develop the modifications and
enhancements. The ownership of the technologies created as a result of this
development agreement remains with the Company. No royalties or other
considerations are required as a part of this agreement.

EFFECTS OF ENVIRONMENTAL LAWS

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

GEOGRAPHICAL SEGMENTS

Sales of equipment to customers in the international market represent an
important source of the Company's revenues. The Company has international
distributors located in 40 countries and covering six continents. The Company
does not believe that there are any special additional risks attendant to sales
in its present international markets.

The following table sets forth certain information relating to export sales for
the three most recent fiscal years ended December 31:

EXPORT SALES
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(thousands) 1995 1994 1993
Latin America and
South America $ 375 2% $ 1,577 15% $ 418 9%
Europe 444 3% 2,187 21% 2,022 42%
Pacific Rim 15,056 95% 6,745 64% 2,320 49%
$15,875 $10,509 $ 4,760

</TABLE>
Export sales represented 57%, 39% and 24% of net sales for the three years
ended December 31, 1995, 1994 and 1993, respectively.

ITEM 2 - PROPERTIES

The Company's executive offices and principal research and development and
marketing activities are located in a one-story, thirty-five thousand square
foot brick and cinder block building located in East Hartford, Connecticut,
leased for a term expiring in December 1996. The Company has a eighty-four
thousand square foot manufacturing facility in Manchester, Connecticut, whose
lease expires in December 1996. The Company also operates two sales, support,
and research and development facilities; one in Irvine, California of four
thousand square feet expiring in December 1998 and one in Berkeley, California
of two thousand square feet expiring in December 1996.

The Company leases office space throughout the United States for sales, service
and administrative functions. Office space for administration and equipment
demonstration is also leased by Scan-Optics, Ltd., in the United Kingdom and
Scan-Optics (Canada), Ltd., both wholly-owned subsidiaries.

ITEM 3 - LEGAL PROCEEDINGS

There are certain claims pending against the Company which arose in the normal
course of business. In the opinion of management, the ultimate outcome of
these matters will not have a material impact on the Company's financial
position, results of operations or liquidity.

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

The Company did not submit any matter during the fourth quarter of 1995 to a
vote of the stockholders.

EXECUTIVE AND OTHER OFFICERS OF THE REGISTRANT

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

Richard I. Tanaka 67 Chairman, Chief Executive
Officer and Director 1989

James C. Mavel 50 Chief Operating Officer
and President 1996

Robert L. Bell 44 Vice President -
Business Development 1993

William H. Cuddy 60 Secretary 1984

Richard C. Goyette 44 Vice President - 1996
Sales and Marketing

Clarence W. Rife 56 Vice President -
Customer Relations 1975

John B. Sayre 60 Vice President -
Facilities and Manufacturing 1988

Michael J. Villano 36 Chief Financial Officer
and Vice President 1992

Dr. Tanaka joined the Company in September 1989 as Chairman of the Board and
Chief Executive Officer. Prior to joining the Company, Dr. Tanaka was
President of Lundy Electronics and Systems, Inc., a division of TransTechnology
Corp. from 1987 to 1989 and from 1980 to 1986 he was President and CEO of
Systonetics, Inc.

Mr. Mavel joined the Company in January 1996 as Chief Operating Officer and
President. Prior to joining the Company, from 1992 through 1995, Mr. Mavel
was Vice President and General Manager of the Imaging Systems Division of
Unisys. From 1991 to 1992, he was Group Vice President of the Financial
Information Systems Division of National Data Corporation.

Mr. Bell joined the Company in August 1993 as Vice President - Product
Development. Prior to this date, he was a consultant for the design and
development of information networks from 1991 to 1992 and from 1989 to 1991 he
was President of Bluebonnet, a research organization for advanced
telecommunications systems. From 1979 to 1989 he held various positions with
Recognition International, Inc.

Mr. Cuddy has been a partner in the law firm of Day, Berry and Howard since
1968. He was elected to the position of Corporate Secretary in September 1984.

Mr. Goyette joined the Company in March 1996 as Vice President - Sales and
Marketing. Prior to joining the Company, from 1993 through 1995, Mr.
Goyette was Vice President of the Imaging Systems Group of Unisys. From 1992
to 1993, he was Vice President of the Software Products Group of Unisys. From
1990 to 1992 he was Vice President of Corporate Information Productivity
Systems of Unisys.

Mr. Rife has been employed by the Company since 1969 and was elected to the
position of Vice President in 1975. He is currently Vice President - Customer
Relations.

Mr. Sayre joined the Company in December 1988 as Vice President - Facilities
and Manufacturing. Prior to this date he held various management positions
with Pratt and Whitney, Division of United Technologies Corporation, from 1985
to 1988 and previously with LTV/Republic Steel from 1980 to 1985.

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

The executive officers are elected for a one year term at the Directors'
meeting following the Annual Meeting of Stockholders each year. There are no
family relationships between any of the listed officers and directors.

PART II

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

COMMON STOCK MARKET PRICES AND DIVIDENDS

The following is a two year history of Common Stock prices for each quarter.
The table sets forth the high and low closing quotations per share for the
periods indicated of the Common Stock in the over-the-counter market based upon
information provided by the National Association of Security Dealers, Inc. The
closing quotations represent prices between dealers and do not include retail
markups, markdowns or commissions and may not represent actual transactions.
There were 1,419 Common stockholders of record at December 31, 1995.

The Company has not paid any dividends on its Common Stock and the Board of
Directors of the Company has no present intention of declaring dividends in the
foreseeable future. The declaration and payment of dividends in the future
will be determined by the Board of Directors in light of conditions then
existing, including the Company's earnings, financial condition, capital
requirements and other factors.

<TABLE>
<CAPTION>
Quarter Ended March 31 June 30 September 30 December 31
High Low High Low High Low High Low
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995 6 1/4 4 3/4 5 3/4 4 1/8 5 1/8 3 5/8 3 5/8 2 1/8
1994 8 1/8 4 3/4 9 1/8 5 3/8 7 1/2 5 5/8 7 3/8 5 1/2
</TABLE>
<PAGE>
ITEM 6 - SELECTED FINANCIAL DATA
SCAN-OPTICS, INC. AND SUBSIDIARIES
FIVE YEAR SUMMARY OF OPERATIONS
SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
(thousands, except share data) 1995 1994 1993 1992 1991
<S> <C> <C> <C> <C> <C>
Net Operating Revenues $ 42,084 $ 43,889 $ 36,381 $ 37,893 $ 42,374
Income (loss) before income taxes
and extraordinary gain $ (1,327) $ 1,244 $ (932) $ (1,493) $ 687
Income taxes (benefit) (72) (40) 49 118 183
Income (loss) before extraordinary
gain (1,255) 1,284 (981) (1,611) 504
Extraordinary gain on retirement of debt 185
Net income (loss) $ (1,255) $ 1,284 $ (981) $ (1,611) $ 689

Earnings (loss) per share before
extraordinary gain on retirement
of debt $ (0.19) $ 0.19 $ (0.15) $ (0.25) $ 0.08
Earnings (loss) per share $ (0.19) $ 0.19 $ (0.15) $ (0.25) $ 0.11
Average common and common
equivalent shares outstanding 6,620,270 6,859,544 6,345,137 6,321,922 6,459,768

SELECTED BALANCE SHEET DATA

Total assets $ 29,514 $ 29,619 $ 27,878 $ 26,995 $ 28,775
Working capital $ 14,239 $ 14,015 $ 13,135 $ 13,042 $ 14,092
Total stockholders' equity $ 17,751 $ 18,731 $ 17,097 $ 18,012 $ 19,798
</TABLE>
The Company has not paid any dividends for the five year period ended December
31, 1995.

The above financial data should be read in conjunction with the related
consolidated financial statements and notes thereto.
<PAGE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents increased by $.1 million from 1994 to 1995.

Total Company borrowings decreased $2.0 million to $.3 million at December 31,
1995. The average borrowing level for 1995 was $5.3 million compared to $4.8
million for 1994. The change in borrowing level is due in part to the loss
incurred in 1995 as well as the timing of cash flows throughout the year.

Operating activities provided $2.4 million of cash in 1995 compared to $1.2
million in 1994. The increase is attributable to a significant customer
deposit received in the last quarter of 1995, offset partially by increases in
accounts receivable and inventory.

Non-cash expenses recorded in 1995 were $2.5 million vs. $2.6 million in 1994.
These expenses primarily relate to depreciation, amortization, provisions for
losses on accounts receivable and provisions for inventory obsolescence.

Accounts receivable increased $1.2 million from 1994 reflecting the increase in
sales in the fourth quarter of 1995 compared to 1994.

Total inventories decreased $.5 million from 1994 levels. Manufacturing
inventories decreased $3.1 million during the year due to transfers of product
to the customer service inventory that are utilized in support of our
maintenance contracts. The items transferred mainly represent non-current
products with significant numbers of installed machines requiring this supply
of parts. The transfer of $2.5 million accounted for the change in both
manufacturing and customer service inventories.

Plant and equipment increased $.3 million in 1995. The major components of
this increase include assets acquired as a result of the Company's license of
the Image EMC product, engineering development equipment and test equipment,
and the upgrading of the Company's show booth.

Accounts payable and accrued expenses increased $.9 million from 1994 levels.
Accounts payable increased $.1 million due to timing of cash flows related to
inventory purchases. Accrued expenses decreased $1.0 million due to the
payment of the royalty accrual upon completion of a research and development
agreement during June of 1995.

Customer deposits increased $3.7 million and relate primarily to deliveries of
equipment in 1996 to a Japanese health agency.

On March 11, 1996, the Company received a commitment letter extending the
maturity date of the Company's outstanding bank line of credit to May 29, 1997.
Management believes that the line of credit provides the Company with
sufficient financial resources to meet its working capital and capital
expenditure requirements.

RESULTS OF OPERATIONS -- 1995 VS. 1994

TOTAL REVENUES decreased $1.8 million from 1994.

NET SALES increased $.7 million from the prior year. North American sales
decreased $4.6 million and international sales increased $5.3 million from
1994. The North American sales decreased due to the completion of the primary
implementation of the IRS SCRIPS award in 1994. International sales in the
Pacific Rim showed significant growth from 1994 to 1995. Sales to a Japanese
health agency increased sales volume in this marketplace by 123% or $8.3
million. Sales to Latin America and South America decreased 76% or $1.2
million. Sales to Europe decreased 80% or $1.8 million over the prior year.
These decreases are reflective of large non-recurring sales which occurred in
the prior year.

SERVICE REVENUES decreased $2.3 million from 1994 to 1995. Customer service
revenue decreased $1.5 million due to the replacement of older product lines
which included a significant maintenance surcharge with the Series 9000.
Software service revenue decreased $.3 million due to the decrease in North
American sales during the year. Engineering revenue decreased $.5 million from
1994 to 1995 due to the completion of a significant product development
agreement.

COST OF SALES increased $1.9 million from 1994 to 1995. The gross margin
percentage decreased 5.3% from 34.8% in 1994 to 29.5% in 1995. The decrease in
gross margin is due to the shift in revenue mix from domestic sales to
international sales, particularly to the Pacific Rim. Sales to a Japanese
health agency, due to the volume of orders, carried a lower margin percentage.
Additionally, unabsorbed manufacturing expenses increased in 1995 due to the
fluctuations in production volume throughout the year.

MARKETING AND SERVICE EXPENSES decreased by $.7 million in 1995 principally due
to staffing reductions related to changes in the installed base of serviced
equipment.

RESEARCH AND DEVELOPMENT EXPENSES decreased $1.1 million from 1994 mainly due
to the decrease in engineering staff resulting from the corporate
reorganization as well as a decrease in the utilization of outside consultants.

GENERAL AND ADMINISTRATIVE EXPENSES increased $.5 million compared to prior
year mainly due to a $.2 million increase in legal expenses, and a $.1 million
increase in the Company's contribution to the 401(k) plan. Additionally,
outside recruiting firms were utilized in 1995 to fill open positions
in upper management.

RESULTS OF OPERATIONS -- 1994 VS. 1993

TOTAL REVENUES increased $7.5 million from 1993.

NET SALES increased $7.3 million from the prior year. North American sales
increased $2.7 million and international sales increased $4.6 million from
1993. The North American sales increases are reflective of the continued
acceptance of the Series 9000 product line as well as the fulfillment of
the primary implementation of the IRS SCRIPS award. International sales showed
significant growth from 1993 to 1994. The growth occurred in two of the three
major international marketplaces for the Company's products. Sales to a
Japanese health agency increased sales volume to the Pacific Rim by 191% or
$4.4 million. Sales to Latin America and South America increased 272% or $1.2
million as the Company sold a major credit card system to a bank in Mexico.
Sales to Europe increased 8% or $.2 million over the prior year.

SERVICE REVENUES increased $.2 million from 1993 to 1994. Customer service
revenue decreased $.2 million due to the replacement by the Series 9000 of
older product lines which included a significant maintenance surcharge.
Software service revenue increased $.5 million due to the increase in North
American sales and the continued Company focus on software as a growth
business line in the future. Engineering revenue decreased $.1 million from
1993 to 1994.

COST OF SALES increased $5.7 million from 1993 to 1994. The gross margin
percentage decreased 4.8% from 39.6% in 1993 to 34.8% in 1994. The decrease in
gross margin is due to the increase in royalty expense incurred from 1993 to
1994 of $1.2 million. The gross margin percentage remained consistent from
1993 to 1994 after adjusting for the change in royalty expense.

MARKETING AND SERVICE EXPENSES decreased by $1.5 million in 1994. Customer
service expenses decreased $.6 million from the prior year due to parts usage
and amortization expense decreases related to customer service inventory.
Customer service staffing adjustments relating to changes in the installed base
of serviced equipment also accounted for a portion of the decrease. Software
service expenses decreased $.2 million due to the reduction in travel expenses
related to system acceptances in 1994. Marketing expenses decreased $.7
million from the prior year of which $.2 million was due to staffing reductions
and the remaining $.5 million was due to the reduction in the requirement for
an accounts receivable provision from 1993 to 1994.

RESEARCH AND DEVELOPMENT EXPENSES increased $1.1 million from 1993 mainly due
to the use of consultants to augment existing staffing.

GENERAL AND ADMINISTRATIVE EXPENSES remained consistent with the prior year.

<PAGE>

(This page has been left intentionally blank.)
<PAGE>

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<PAGE>

REPORT OF INDEPENDENT AUDITORS

Stockholders and Board of Directors
Scan-Optics, Inc.

We have audited the accompanying consolidated balance sheets of Scan-Optics,
Inc. and subsidiaries as of December 31, 1995 and 1994, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1995. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

We conducted our audits in accordance with 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Scan-
Optics, Inc. and subsidiaries at December 31, 1995 and 1994, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

Ernst & Young LLP

Hartford, Connecticut
February 2, 1996, except for the second paragraph of
Note C, as to which the date is March 11, 1996
<PAGE>
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
December 31
(thousands, except share data) 1995 1994
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 281 $ 178
Accounts receivable, less allowance of $413
in 1995 and $279 in 1994 10,297 9,124
Inventories 13,746 14,223
Prepaid expenses and other 1,261 1,083
Total current assets 25,585 24,608

Plant and equipment:
Equipment 14,097 13,928
Leasehold improvements 2,837 2,808
Office furniture and fixtures 1,215 1,158

18,149 17,894
Less allowances for depreciation
and amortization 14,340 13,272
3,809 4,622

Other assets 120 389
Total Assets $ 29,514 $ 29,619
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
December 31
(thousands, except share data) 1995 1994
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable to bank $ 305 $ 2,265
Accounts payable 2,862 2,774
Salaries and wages 909 1,119
Taxes other than income taxes 338 348
Income taxes 185 175
Customer deposits 5,900 2,165
Deferred revenues, net of costs 30
Royalties payable 18 814
Other 829 903
Total current liabilities 11,346 10,593

Other liabilities 417 295

Stockholders' Equity
Preferred stock, par value $.02 per share,
authorized 5,000,000 shares; none
issued or outstanding
Common stock, par value $.02 per share,
authorized 15,000,000 shares;
issued, 6,935,184 shares in 1995 and
6,906,080 shares in 1994 139 138
Common stock Class A Convertible, par
value $.02 per share, authorized 3,000,000
shares; available for issuance 2,145,536 shares,
none issued or outstanding
Capital in excess of par value 34,271 34,202
Retained-earnings deficit (13,433) (12,178)
Foreign currency translation adjustments (315) (388)
Unearned ESOP compensation (265) (397)
20,397 21,377
Less cost of common stock in treasury,
413,500 shares 2,646 2,646
Total stockholders' equity 17,751 18,731
Total Liabilities and Stockholders' Equity $ 29,514 $ 29,619

</TABLE>

See accompanying notes.
<PAGE>
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
Year Ended December 31
(thousands, except share data) 1995 1994 1993
<CAPTION>
<S> <C> <C>
Revenues
Net sales $ 27,642 $ 26,988 $ 19,698
Service revenues 14,309 16,616 16,458
Other operating revenues 133 285 225
Total revenues 42,084 43,889 36,381

Costs and Expenses
Cost of sales 19,487 17,584 11,902
Marketing and service expenses 15,769 16,437 17,940
Research and development expenses 4,574 5,690 4,601
General and administrative expenses 3,142 2,637 2,632
Interest expense 488 376 274
Total costs and expenses 43,460 42,724 37,349
Operating income (loss) (1,376) 1,165 (968)

Other income, net 49 79 36

Income (loss) before income taxes (1,327) 1,244 (932)

Income taxes (benefit) (72) (40) 49
Net Income (Loss) $ (1,255) $ 1,284 $ (981)

Earnings (loss) per share $ (0.19) $ 0.19 $ (0.15)

Average common and common equivalent shares 6,620,270 6,859,544 6,345,137
</TABLE>
See accompanying notes.
SCAN-OPTICS, INC. AND SUBSIDIARIES
<PAGE>
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Foreign
Capital in Retained- Currency Unearned
Common Stock Excess of Earnings Translation ESOP Treasury
(thousands, except share data) Shares Amount Par Value Deficit Adjustments Compensation Stock Total
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance January 1, 1993 6,735,422 $ 135 $ 33,836 $ (12,481) $ (170) $ (662) $ (2,646) $ 18,012

Issuance of common stock upon
exercise of stock options 44,146 95 95
Unearned ESOP compensation
amortization 132 132
Net loss (981) (981)
Foreign currency translation
adjustments (161) (161)

Balance December 31, 1993 6,779,568 135 33,931 (13,462) (331) (530) (2,646) 17,097

Issuance of common stock upon
exercise of stock options 126,512 3 271 274
Unearned ESOP compensation
amortization 133 133
Net income 1,284 1,284
Foreign currency translation
adjustments (57) (57)

Balance December 31, 1994 6,906,080 138 34,202 (12,178) (388) (397) (2,646) 18,731

Issuance of common stock upon
exercise of stock options 29,104 1 69 70
Unearned ESOP compensation
amortization 132 132
Net loss (1,255) (1,255)
Foreign currency translation
adjustments 73 73

Balance December 31, 1995 6,935,184 $ 139 $ 34,271 (13,433) $ (315) $ (265) $ (2,646) $ 17,751
</TABLE>
See accompanying notes.
<PAGE>
SCAN-OPTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

Year Ended December 31
(thousands) 1995 1994 1993
<S> <C> <C> <C>
Operating Activities
Net income (loss) $ (1,255) $ 1,284 $ (981)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 1,214 1,198 1,204
Amortization 1,034 923 1,128
Provision for losses on accounts receivable 236 287
Provision for inventory obsolescence 477 1,043
Deferred income taxes (140)
Changes in operating assets and liabilities:
Accounts receivable (1,409) (115) (372)
Inventories, prepaid expenses and other (735) (2,392) (3,938)
Accounts payable and accrued expenses (206) (534) 586
Income taxes 10 (26) 91
Deferred revenues, net of costs (30) (798) 601
Customer deposits 3,735 542 1,598
Royalties payable (796) 689 61
Other 596 (6) 233
Net cash provided by operating activities 2,394 1,242 1,401

Investing Activities
Purchases of plant and equipment (401) (1,870) (396)
Net cash used by investing activities (401) (1,870) (396)

Financing Activities
Proceeds from issuance of common stock 70 274 95
Proceeds from borrowings 31,777 25,219 23,149
Principal payments on borrowings (33,737) (24,970) (24,133)
Net cash provided (used) by financing activities (1,890) 523 (889)

Increase (decrease) in cash and cash equivalents 103 (105) 116

Cash and Cash Equivalents at Beginning Of Year 178 283 167
Cash and Cash Equivalents at End of Year $ 281 $ 178 $ 283

Supplemental Cash Flow Information
Interest paid $ 502 $ 342 $ 270
Income taxes paid $ 59 $ 79 $ 210
</TABLE>

See accompanying notes.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A -- ACCOUNTING POLICIES

ORGANIZATION: The Company designs and manufactures information processing
systems used for imaging, data capture, document processing and information
management. The Company's systems, software and services are marketed world-
wide to commercial and government organizations either directly by the Company
sales organization or through distributors. The Company's business is
vulnerable to a number of factors beyond its control. These include (1) the
effect of a weakening in the domestic and international economies which
potentially impacts capital investments by customers, (2) the cyclical nature
of funding within federal and state government agencies, (3) competition from
similar products, (4) the implementation of other technologies which
may provide alternative solutions, and (5) the stability of our sole source
suppliers.

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

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

INVENTORIES: Inventories are valued at the lower of cost (first-in, first-out
method) or market.

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

REVENUE RECOGNITION: Revenues from maintenance and application software
services are recognized as earned. Revenues relating to sales of certain
equipment (principally optical character recognition equipment) are recognized
upon acceptance of the related application software.

INCOME TAXES: Deferred income taxes are provided for differences between the
income tax and the financial reporting bases of assets and liabilities at the
statutory tax rates that will be in effect when the differences are expected to
reverse.

STOCK BASED COMPENSATION: The Company generally grants stock options to key
employees and members of the board of directors with an exercise price equal to
the fair value of the shares on the date of grant. The Company accounts for
<PAGE>
stock option grants in accordance with APB Opinion No. 25, Accounting for Stock
Issued to Employees, and, accordingly, recognizes no compensation expense for
the stock option grants.

EARNINGS (LOSS) PER SHARE: Earnings (loss) per share amounts are computed
using weighted average common and common equivalent shares outstanding during
the year assuming conversion of the common stock equivalents into common stock,
if dilutive, at the weighted average market price of the stock for the year.
All shares held by the Company's Employee Stock Ownership Plan (ESOP) are
considered outstanding.

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

RECLASSIFICATIONS: Certain 1994 and 1993 amounts have been reclassified to
conform to current year presentation.

NOTE B -- INVENTORIES

The components of inventories were as follows:
<TABLE>
<CAPTION>
December 31
(thousands) 1995 1994
<S> <C> <C>
Finished goods $ 2,823 $ 2,533
Work-in-process 2,820 2,506
Service parts 5,043 2,409
Materials and component parts 3,060 6,775
$13,746 $14,223

</TABLE>
NOTE C -- CREDIT ARRANGEMENTS

The Company has a line of credit agreement (Agreement) with a bank which
expires on May 31, 1996. The Agreement has two components, a $4 million line
(international) guaranteed by a third party bank which is collateralized by
international accounts receivable and inventory, and which bears interest at
prime (8 1/2% at December 31, 1995); and a $4 million line (domestic) which is
collateralized by domestic accounts receivable and inventory, and which bears
interest at prime plus 1/2% (9% at December 31, 1995). The weighted average
interest rate on borrowings during 1995 and 1994 was 9.1% and 7.9%
respectively. The unused portion of the $4 million domestic line is subject to
a commitment fee of 3/4% per annum. Borrowings under the Agreement are
subject to various limitations based upon percentages of eligible receivables
and inventories of the Company. The available balance on the total line of
credit was $7,014,000 at December 31, 1995. In addition, the Agreement contains
covenants which, among other things, require the maintenance of specified
working capital, debt to equity ratios, net income levels and tangible net
worth levels.

On March 11, 1996, the Company received a commitment letter from the bank
extending the maturity date of the outstanding line of credit to May 29, 1997.
The line of credit was reduced from $8 million to $6 million ($3 million each
for the international and domestic lines) which is reflective of the Company's
current cash availability and projected cash flow requirements for the next
twelve months. The commitment letter is subject to the extension of the
guarantee by the third party bank on the international line. The Company
expects that the guarantee will be extended.

The carrying value of the Company's credit arrangement approximates its fair
value.

NOTE D -- CAPITAL STOCK

The Board of Directors is authorized to issue shares of the Company's preferred
stock in series, to establish from time to time the number of shares to be
included in each series and to fix the designation, powers, preferences and
other terms and conditions with respect to such stock. No shares have been
issued to date.

Class A stock has the same rights as common stock, except that its holders may
not vote for the election of directors, and it is convertible into common stock
on a share for share basis. On September 2, 1994, all outstanding shares of
Class A stock were converted to common stock.

At December 31, 1995, the Company had reserved 1,163,774 shares of common stock
for the exercise of warrants (43,000) and the issuance or exercise of stock
options (1,120,774).

NOTE E -- COMMON STOCK WARRANTS

Warrants outstanding generally have anti-dilution provisions and expire between
1996 and 1998.

<TABLE>
<CAPTION>
Price Per Share Shares
<S> <C> <C>
Warrants outstanding January 1, 1993 $3.63 18,000
Granted in 1993 5.38 25,000
WARRANTS OUTSTANDING
DECEMBER 31, 1993, 1994 AND 1995 $3.63 - $5.38 43,000
</TABLE>
<PAGE>
NOTE F -- STOCK OPTION PLANS

The Company has five stock option plans for key employees and board members.
Options granted under the plans are for a period of ten years and at prices not
less than the fair market value of the shares at date of grant except that the
price for non-qualified options may not be less than the par value of the
stock. Options for employees are not exercisable for one year following the
date of grant and then are exercisable in such installments during the period
prior to expiration as the Stock Option Committee shall determine. Options for
Directors are not exercisable until six months after the grant thereof.
Options may be exercised from time to time, in part or as a whole, on a
cumulative basis as determined by the Stock Option Committee under all stock
option plans.

The following schedule summarizes the changes in stock options for each of the
three years in the period ended December 31, 1995:

<TABLE>
<CAPTION>
Number of Option Price
Shares Per Share
<S> <C> <C>
Outstanding January 1, 1993
(390,266 exercisable) 705,759 $1.25 to $9.63
Granted 139,000 3.25 to 6.00
Exercised (44,146) 1.50 to 3.13
Cancelled (16,502) 1.50 to 5.75

Outstanding December 31, 1993
(559,388 exercisable) 784,111 1.25 to 9.63
Granted 153,500 5.75 to 9.00
Exercised (126,512) 1.25 to 3.63
Cancelled (36,582) 3.13 to 6.00

Outstanding December 31, 1994
(531,273 exercisable) 774,517 1.50 to 9.63
Granted 91,000 2.13 to 6.00
Exercised (29,104) 2.00 to 3.25
Cancelled (49,698) 2.00 to 9.25

OUTSTANDING DECEMBER 31, 1995
(587,260 EXERCISABLE) 786,715 $1.50 to $9.63

</TABLE>
At December 31, 1995 there were 334,059 options available for grant.

<PAGE>
NOTE G -- RESEARCH AND DEVELOPMENT AGREEMENTS

During 1995, the Company entered into $700,000 of product development
agreements with a specific customer, which required various modifications and
enhancements to the Company's Series 9000 product. The Company recorded
revenue related to this development agreement of $336,000 in 1995. These
revenues offset related costs incurred to develop the modifications and
enhancements. The ownership of the technologies created as a result of this
development agreement remains with the Company. No royalties or other
considerations are required as a part of this agreement.

NOTE H -- EMPLOYEE BENEFITS

The Company maintains a Retirement Savings Plan for United States employees.
Under this plan, all employees may contribute up to 15% of their salary to a
retirement account up to the maximum amount allowed by law. The Company
contributed an amount equal to 50% of the first 4% contributed by the
participant in 1995, and 25% of the first 4% in 1994 and 1993. The Company's
contributions to this plan were $205,000, $107,000 and $99,000 for 1995, 1994
and 1993, respectively.

The Company sponsors an Employee Stock Ownership Plan (the Plan) covering
substantially all full-time employees. The Plan, which is a tax qualified
employee benefit plan, was adopted by the Board of Directors of the Company on
January 29, 1988 to provide retirement benefits for employees. The Plan
borrowed $1,325,000 to purchase 260,000 shares of the Company's stock
to be allocated to participants ratably over a ten year period. The ESOP loan
was guaranteed by the Company and the outstanding balance of the loan was
repaid in 1991. At December 31, 1995, there were 52,000 unallocated shares.
In 1995, 1994 and 1993 the expenses related to the Plan were $132,000 in each
year.
<PAGE>
NOTE I -- INCOME TAXES

The Company has approximately $7,000,000 and $5,200,000 of net operating loss
carryforwards for federal and state income tax purposes, respectively, which
are scheduled to expire periodically between 1996 and 2010. For financial
reporting purposes a valuation allowance has been recognized to offset the
deferred tax assets related to those carryforwards and other temporary
differences.

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

<TABLE>
<CAPTION>
December 31
(thousands) 1995 1994
<S> <C> <C>
Deferred tax assets:
Net operating losses $ 3,422 $ 3,541
Depreciation 99 97
Inventory valuation 831 964
Accounts receivable reserves 167 32
Revenue recognition 13 86
Vacation accrual 258 265
Other 279 253
Total deferred tax assets 5,069 5,238

Deferred tax liabilities:
Depreciation and other (82) (100)

Valuation allowance (4,987) (5,138)
Net deferred taxes $ 0 $ 0
</TABLE>
For financial reporting purposes, income (loss) before income taxes is set
forth in the following tabulation:

<TABLE>
<CAPTION>
Year Ended December 31
(thousands) 1995 1994 1993
<S> <C> <C> <C>
Domestic $ (407) $ 2,150 $ (971)
Foreign (920) (906) 39
$ (1,327) $ 1,244 $ (932)
</TABLE>
<PAGE>
Income taxes (benefit) are summarized as follows:
<TABLE>
<CAPTION>
Year Ended December 31
(thousands) 1995 1994 1993
<S> <C> <C> <C>
Currently payable
(refundable):
Foreign $ (132) $ (100) $ 140
State 60 60 49
(72) (40) 189
Deferred (benefit):
Foreign (140)
(140)
$ (72) $ (40) $ 49

</TABLE>
A reconciliation of the effective tax rate to the statutory rate is as follows:

<TABLE>
<CAPTION>
Year Ended December 31
1995 1994 1993
<S> <C> <C> <C>
Statutory federal income tax rate (34%) 34% (34%)
State income taxes, net of federal benefit 5 5 5
Foreign income taxes (benefit) (10) (8)
Net operating loss carryforward
(benefit) limitation 34 (34) 34
( 5%) (3%) 5%

</TABLE>
NOTE J -- LEASE COMMITMENTS

The Company's principal lease commitments are for its corporate offices and
research and development facility in East Hartford, Connecticut, its
manufacturing facility in Manchester, Connecticut and its research and
development facilities in Irvine and Berkeley, California. The East
Hartford and Manchester leases expire on December 31, 1996, the Irvine lease
expires on December 31, 1998 and the Berkeley lease expires on December 20,
1996. Minimum rental payments for all noncancelable leases which are operating
leases with terms equal to or in excess of one year as of December 31, 1995 are
as follows: 1996 - $496,000, 1997 - $41,000 and 1998 - $42,000.

Rental expense for the years ended December 31, 1995, 1994 and 1993 was
$887,000, $808,000, and $792,000, respectively.

NOTE K -- CONTINGENCIES

Export sales by geographic area were as follows:

<TABLE>
<CAPTION>
Year Ended December 31
(thousands) 1995 1994 1993
<S> <C> <C> <C>
Latin America and South America $ 375 $ 1,577 $ 418
Europe 444 2,187 2,022
Pacific Rim 15,056 6,745 2,320
$ 15,875 $ 10,509 $ 4,760

</TABLE>
In 1995, one customer accounted for approximately 31% of consolidated revenues.
Two customers accounted for approximately 22% of consolidated revenues in 1994,
each at 11%. No single customer accounted for more than 10% of consolidated
revenues in 1993.

<PAGE>

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

None.
PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information pertaining to Directors and additional information pertaining to
Executive Officers is included, under the caption "Governance of the Company",
and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in
the Company's definitive proxy statement for the Annual Meeting of Stockholders
to be held on May 15, 1996 and is incorporated herein by reference and
made a part hereof.
<PAGE>

ITEM 11 - EXECUTIVE COMPENSATION

This information is included, under the caption "Executive Compensation", in
the Company's definitive proxy statement for the Annual Meeting of Stockholders
to be held on May 15, 1996 and is incorporated herein by reference.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

This information is included, under the caption "Share Ownership of
Management", in the Company's definitive proxy statement for the Annual Meeting
of Stockholders to be held on May 15, 1996 and is incorporated herein by
reference.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

This information is included, under the caption "Certain Transactions", in the
Company's definitive proxy statement for the Annual Meeting of Stockholders to
be held on May 15, 1996 and is incorporated herein by reference.

PART IV

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

(a) The following consolidated financial statements and report of independent
auditors of the Company and its subsidiaries are included in Item 8:

(1) Report of Independent Auditors:

Consolidated Balance Sheets at December 31, 1995 and 1994

Consolidated Statements of Operations for the years ended
December 31, 1995, 1994 and 1993

Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1995, 1994 and 1993

Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1994 and 1993

Notes to Consolidated Financial Statements -
December 31, 1995

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

Schedule II -- Valuation and Qualifying Accounts
<PAGE>
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.

(3) Listing of Exhibits

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

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

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

*3.2(a) By-laws of the Company (filed as Exhibit 3.2 to the
Company's Registration Statement on Form S-1, File No.
2-70277).

*3.2(b) Amendments to By-laws of the Company adopted May 17,
1984, included in Exhibits A and B in the Company's
proxy statement dated April 17, 1984 for the Annual
Meeting of Stockholders held May 17, 1984.

*3.2(c) Amendment to By-laws of the Company adopted at the
meeting of the Board of Directors on January 28, 1991,
included as Exhibit 3.2(c) in the Company's Annual
Report on Form 10K filed for the year ended December
31, 1991.

*+10.1 The Scan-Optics, Inc. 1979 Incentive and Non-Qualified
Stock Option Plan included in Exhibit B in the Company's
Proxy statement dated June 8, 1979 for the Annual
Meeting of Stockholders held on June 27, 1979.

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

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

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

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

* +10.6 Employment agreement between Richard I. Tanaka and Scan-
Optics, Inc. effective September 5, 1989, included as
Exhibit 10.7 in the Company's Annual Report on Form 10-K
filed for the year ended December 31, 1991.

* +10.7 Severance agreement between Clarence W. Rife and Scan-
Optics, Inc.dated December 17, 1986, included as Exhibit
10.8 in the Company's Annual Report on Form 10-K filed
for the year ended December 31, 1991.

* +10.8 Executive severance agreement between certain officers
and Scan-Optics, Inc. dated July 28, 1992, included as
Exhibit 10.8 in the Company's Annual Report on Form 10-K
filed for the year ended December 31, 1992.

11. Computation of earnings per share for the last three
fiscal years.

* 22. List of subsidiaries of the Company, included as Exhibit
10.8 in the Company's Annual Report on Form 10-K filed
for the year ended December 31, 1993.

23. Consent of Independent Auditors.

27. Financial Data Schedule.

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

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

(b) Reports on Form 8-K

No report on Form 8-K was filed for the quarter ended
December 31, 1995.

The exhibits required by this item are included herein.

(d) Financial Statement Schedule

The response to this portion of Item 14 is submitted as
a separate section of this report.
<PAGE>
SIGNATURES

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

By: /ss/
_________________
Richard I. Tanaka
Chairman, Chief Executive
Officer and Director
Date: March 25, 1996

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

/ss/
_________________
Richard I. Tanaka Chairman, Chief Executive Officer
and Director (Principal
Executive Officer)
Date: March 25, 1996

/ss/
______________________
Michael J. Villano Chief Financial Officer and Vice
President
(Principal Financial and
Accounting Officer)
Date: March 25, 1996
/ss/
_______________________
Logan Clarke, Jr. Director March 25, 1996

/ss/
_______________________
Richard J. Coburn Director March 25, 1996

/ss/
_______________________
E. Bulkeley Griswold Director March 25, 1996

/ss/
_______________________
Lyman C. Hamilton, Jr. Director March 25, 1996

/ss/
_______________________
Robert H. Steele Director March 25, 1996

A majority of the Directors
<PAGE>
SCHEDULE VIII
SCAN-OPTICS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
THREE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
(thousands)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
Additions
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Period Expenses Accounts Deductions (1) Period
<S> <C> <C> <C> <C>
Year ended December 31, 1995:
Reserve for doubtful accounts $ 279 $ 236 $ 102 $ 413

Year ended December 31, 1994:
Reserve for doubtful accounts $ 313 $ 34 $ 279

Year ended December 31, 1993:
Reserve for doubtful accounts $ 290 $ 287 $ 264 $ 313
</TABLE>

(1) Uncollectible accounts written off, net of recoveries
<PAGE>
EXHIBIT 11.

SCAN-OPTICS, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(thousands, except share data)

<TABLE>
Year Ended December 31
1995 1994 1993
<S> <C> <C> <C>
Primary earnings per share

Average common shares outstanding 6,512,475 6,030,469 5,490,673

Average Class A common shares outstanding 427,232 854,464

Net effect of dilutive stock options and
warrants - based on the treasury stock
method using the weighted average market
price for the year 107,795 401,843

Total 6,620,270 6,859,544 6,345,137

Net income (loss) $ (1,255) $ 1,284 $ (981)

Earnings (loss) per share $ (0.19) $ 0.19 $ (0.15)
</TABLE>
<PAGE>
EXHIBIT 23 -- CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-37253, Form S-8 No. 33-37829, Form S-8 No. 33-16362, Form S-8
No. 2-93268 and Form S-8 No. 2-65503) of Scan Optics, Inc. and in the related
prospectuses of our report dated February 2, 1996, except for the second
paragraph of Note C, as to which the date is March 11, 1996, with respect
to the consolidated financial statements and schedule of Scan-Optics, Inc. and
subsidiaries included in the Annual Report (Form 10-K) for the year ended
December 31, 1995.

Ernst & Young LLP

Hartford, Connecticut
March 25, 1996
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.

<ARTICLE> 5
EXHIBIT 27.

SCAN-OPTICS, INC.
FINANCIAL DATA SCHEDULE

<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1994 DEC-31-1993
<PERIOD-END> DEC-31-1995 DEC-31-1994 DEC-31-1993
<CASH> 281,000 178,000
<SECURITIES> 0 0
<RECEIVABLES> 10,297,000 9,124,000
<ALLOWANCES> 413,000 279,000
<INVENTORIES> 13,746,000 14,223,000
<ASSETS> 25,585,000 24,608,000
<PROPERTY, PLANT AND EQUIPMENT> 18,149,000 17,894,000
<ACCUMULATED DEPRECIATION> 14,340,000 13,272,000
<TOTAL ASSETS> 29,514,000 29,619,000
<TOTAL CURRENT LIABILITIES> 11,346,000 10,593,000
<BONDS, MORTGAGES AND SIMILAR DEBT> 0
0
0
<COMMON STOCK> 139,000 138,000
<OTHER STOCKHOLDERS' EQUITY> 17,612,000 18,593,000
<TOTAL-LIABILITY-AND-EQUITY> 29,514,000 29,619,000
<NET SALES OF TANGIBLE PRODUCTS> 27,642,000 26,988,000 19,698,000
<TOTAL REVENUE> 42,084,000 43,889,000 36,381,000
<COST OF TANGIBLE GOODS SOLD> 19,487,000 17,584,000 11,902,000
<TOTAL COSTS AND EXPENSES APPLICABLE
TO SALES AND REVENUES> 43,460,000 42,724,000 37,349,000
<OTHER COSTS AND EXPENSES> 0 0 0
<PROVISION FOR DOUBTFUL ACCOUNTS AND NOTES> 0 0 0
<INTEREST AND AMORTIZATION OF DEBT DISCOUNT> 0 0 0
<INCOME BEFORE TAXES AND OTHER ITEMS> ( 1,327,000) 1,244,000 (932,000)
<INCOME TAX EXPENSE> (72,000) (40,000) 49,000
<INCOME/LOSS CONTINUING OPERATIONS> (1,255,000) 1,284,000 (981,000)
<DISCONTINUED OPERATIONS> 0 0 0
<EXTRAORDINARY ITEMS> 0 0 0
<CUMULATIVE EFFECT-CHANGES IN ACCOUNTING
PRINCIPLES> 0 0 0
<NET INCOME OR LOSS> (1,255,000) 1,284,000 (981,000)
<EARNINGS PER SHARE - PRIMARY> (.19) .19 (.15)
<EARNINGS PER SHARE - FULLY DILUTED> (.19) .19 (.15)

</TABLE>