**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                        |
|-------------------------------------------------------|
| **ý**                                            |   | **Quarterly Report Pursuant to Section 13 or 15(d) of  the Securities Exchange Act of 1934** |
|                                                  |   |   |
| **For the quarterly period ended June 30, 2004** |
|                                                  |   |   |
| **OR**                                                |
|                                                  |   |   |
| **o**                                                 |   | **Transition Report Pursuant to Section 13 or 15(d) of  the Securities Exchange Act of 1934** |

 

**CommissionFile Number 0-9859**

 

**BANCTEC,INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                    |   | **75-1559633**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation  or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **2701 E. Grauwyler Road, Irving, Texas**                       |   | **75061**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |
|                                                            |   |                                 |
| **(972) 579-6000**                                              |
| (Registrant’s telephone number, including  area code)      |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.   Yes  ý     No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). Yes  o No  ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 

| **Title of  Each Class**               |   | **Number of  Shares Outstanding at  August 12, 2004** |
|----------------------------------------|--------|------------------------------------------------------------|
|                                   |   |                                                       |
| Common Stock, $0.01 par  value         |   | 17,003,838                                                 |
| Class A Common Stock,  $0.01 par value |   |  1,181,946                                            |

 

 

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**PART IFINANCIAL INFORMATION**

** **

**ITEM1.  Financial Statements**

**BANCTEC, INC.CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

 
|                                                                                                                              |   | **June 30,  2004** |    | **December 31,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                              |   | **(Unaudited)**         |    |                        |   |
| CURRENT  ASSETS:                                                                                                                  |   |                    |    |                        |   |
| Cash and cash  equivalents, including restricted cash of $10,768 and $19,578 at  June 30, 2004 and December 31, 2003    |   | $                       | 62,979  |                        | $      | 61,566 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,073 and $1,126 at  June 30, 2004 and December 31, 2003 |   | 46,198                  |    | 39,193                      |   |
| Inventories,  net                                                                                                                 |   | 19,911                  |    | 23,908                      |   |
| Prepaid  expenses                                                                                                                 |   | 6,998                   |    | 4,823                       |   |
| Other current  assets                                                                                                             |   | 1                       |    | 21                          |   |
| Total current  assets                                                                                                             |   | 136,087                 |    | 129,511                     |   |
|                                                                                                                              |   |                    |    |                        |   |
| PROPERTY,  PLANT AND EQUIPMENT, net                                                                                               |   | 39,909                  |    | 44,832                      |   |
|                                                                                                                              |   |                    |    |                        |   |
| OTHER ASSETS:                                                                                                                     |   |                    |    |                        |   |
| Goodwill                                                                                                                          |   | 41,476                  |    | 41,476                      |   |
| Deferred  income tax benefit                                                                                                      |   | 12,806                  |    | 13,796                      |   |
| Other assets                                                                                                                      |   | 8,065                   |    | 9,900                       |   |
| Total other  assets                                                                                                               |   | 62,347                  |    | 65,172                      |   |
|                                                                                                                              |   |                    |    |                        |   |
| TOTAL ASSETS                                                                                                                      |   | $                       | 238,343 |                        | $      | 239,515 |   |
|                                                                                                                              |   |                    |    |                        |   |
| CURRENT  LIABILITIES:                                                                                                             |   |                    |    |                        |   |
| Current  obligations under capital leases                                                                                         |   | $                       | 845     |                        | $      | 1,105 |   |
| Trade accounts  payable                                                                                                           |   | 13,972                  |    | 13,122                      |   |
| Other accrued  expenses and liabilities                                                                                           |   | 43,586                  |    | 36,901                      |   |
| Deferred  revenue                                                                                                                 |   | 15,204                  |    | 22,179                      |   |
| Maintenance  contract deposits                                                                                                    |   | 46,457                  |    | 44,540                      |   |
| Income taxes                                                                                                                      |   | 2,408                   |    | 1,717                       |   |
| Total current  liabilities                                                                                                        |   | 122,472                 |    | 119,564                     |   |
|                                                                                                                              |   |                    |    |                        |   |
| OTHER  LIABILITIES:                                                                                                               |   |                    |    |                        |   |
| Long-term  debt, less current maturities                                                                                          |   | 197,823                 |    | 197,823                     |   |
| Non-current  maintenance contract deposits                                                                                        |   | 28,810                  |    | 30,837                      |   |
| Other  noncurrent liabilities                                                                                                     |   | 16,856                  |    | 16,750                      |   |
| Total other  liabilities                                                                                                          |   | 243,489                 |    | 245,410                     |   |
|                                                                                                                              |   |                    |    |                        |   |
| Total  liabilities                                                                                                                |   | 365,961                 |    | 364,974                     |   |
| COMMITMENTS  AND CONTINGENCIES                                                                                                    |   |                    |    |                        |   |
|                                                                                                                              |   |                    |    |                        |   |
| SERIES A  PREFERRED STOCK (Note 3)                                                                                                |   | —                  |    | 16,568                      |   |
| SERIES B  PREFERRED STOCK (Note 3)                                                                                                |   | —                  |    | 10,609                      |   |
|                                                                                                                              |   |                    |    |                        |   |
| STOCKHOLDERS’ DEFICIT:                                                                                                       |   |                    |    |                        |   |
| Cumulative  preferred stock - authorized, 1,000,000 shares of $0.01 par value at  June 30, 2004 and December 31, 2003   |   |                    |    |                        |   |
| Series A  preferred stock - issued and outstanding, 100,667 shares at June 30,  2004 and December 31, 2003              |   | 17,458                  |    | —                      |   |
| Series B  preferred stock - issued and outstanding, 35,520 shares at June 30, 2004  and December 31, 2003               |   | 11,964                  |    | —                      |   |
| Common stock  authorized, 22,000,000 shares of $0.01 par value at June 30, 2004 and  December 31, 2003:                 |   |                    |    |                        |   |
| Common  stock-issued and outstanding 17,003,838 shares at June 30, 2004 and  December 31, 2003                          |   | 170                     |    | 170                         |   |
| Class A common  stock-issued and outstanding 1,181,946 shares at June 30, 2004 and  December 31, 2003                   |   | 12                      |    | 12                          |   |
| Subscription  stock warrants                                                                                                      |   | 3,726                   |    | 3,726                       |   |
| Additional paid-in  capital                                                                                                       |   | 124,793                 |    | 127,038                     |   |
| Accumulated  deficit                                                                                                              |   | (271,491                | )       | (269,020                    | )      |
| Accumulated  other comprehensive loss                                                                                             |   | (14,250                 | )       | (14,562                     | )      |
| Total  stockholders’ deficit                                                                                                 |   | (127,618                | )       | (152,636                    | )      |
|                                                                                                                              |   |                    |    |                        |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                 |   | $                       | 238,343 |                        | $      | 239,515 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**

 
|                                                 |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                                 |   | **2004**                             |   | **2003**                           |   | **2004** |   | **2003** |   |
|                                                 |   | **(In thousands)**                   |   | **(In thousands)**                 |   |
| REVENUE                                              |   |                                 |   |                               |   |   |   |   |   |
| Equipment and  software                              |   | $                                    | 42,060 |                               | $      | 38,239 |   | $ | 74,586 |   | $ | 72,998 |   |
| Maintenance  and other services                      |   | 57,759                               |   | 58,804                             |   | 114,317 |   | 114,797 |   |
|                                                 |   | 99,819                               |   | 97,043                             |   | 188,903 |   | 187,795 |   |
| COST OF SALES                                        |   |                                 |   |                               |   |   |   |   |   |
| Equipment and  software                              |   | 28,198                               |   | 25,497                             |   | 47,433 |   | 48,715 |   |
| Maintenance  and other services                      |   | 47,245                               |   | 46,663                             |   | 97,750 |   | 91,709 |   |
|                                                 |   | 75,443                               |   | 72,160                             |   | 145,183 |   | 140,424 |   |
| Gross profit                                         |   | 24,376                               |   | 24,883                             |   | 43,720 |   | 47,371 |   |
|                                                 |   |                                 |   |                               |   |   |   |   |   |
| OPERATING  EXPENSES                                  |   |                                 |   |                               |   |   |   |   |   |
| Product  development                                 |   | 2,078                                |   | 3,675                              |   | 4,563 |   | 7,392 |   |
| Selling,  general and administrative                 |   | 14,561                               |   | 15,448                             |   | 27,453 |   | 30,172 |   |
|                                                 |   | 16,639                               |   | 19,123                             |   | 32,016 |   | 37,564 |   |
| Income from  operations                              |   | 7,737                                |   | 5,760                              |   | 11,704 |   | 9,807 |   |
|                                                 |   |                                 |   |                               |   |   |   |   |   |
| OTHER INCOME  (EXPENSE):                             |   |                                 |   |                               |   |   |   |   |   |
| Interest  income                                     |   | 153                                  |   | 352                                |   | 291 |   | 409 |   |
| Interest  expense                                    |   | (4,781                               | )      | (4,846                             | )      | (9,554 | ) | (9,668 | ) |
| Sundry, net                                          |   | (1,498                               | )      | 195                                |   | (1,992 | ) | 1,398 |   |
|                                                 |   | (6,126                               | )      | (4,299                             | )      | (11,255 | ) | (7,861 | ) |
| INCOME BEFORE  INCOME TAXES                          |   | 1,611                                |   | 1,461                              |   | 449 |   | 1,946 |   |
| INCOME TAX  EXPENSE                                  |   | 3,290                                |   | 1,158                              |   | 2,920 |   | 1,789 |   |
| NET INCOME  (LOSS)                                   |   | (1,679                               | )      | 303                                |   | (2,471 | ) | 157 |   |
| PREFERRED  STOCK DIVIDENDS AND ACCRETION OF DISCOUNT |   | (1,151                               | )      | (975                               | )      | (2,245 | ) | (1,902 | ) |
| NET LOSS  APPLICABLE TO COMMON STOCK                 |   | (2,830                               | )      | $                                  | (672   | ) | $ | (4,716 | ) | $ | (1,745 | ) |
|                                                      |        |                                      |        |                                    |        |  |  |  |  |  |  |  |  |

 

See notes to unaudited condensedconsolidated financial statements.

 

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

 
|                                                                            |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                            |   | **2004**                           |   | **2003** |   |
|                                                                            |   | **(In thousands)**                 |   |
| CASH FLOWS  FROM OPERATING ACTIVITIES                                           |   |                               |   |   |   |
| Net income                                                                      |   | $                                  | (2,471 | ) | $ | 157 |   |
| Adjustments to  reconcile to cash flows provided by operations:                 |   |                               |   |   |   |
| Depreciation  and amortization                                                  |   | 7,844                              |   | 10,238 |   |
| Provision for  doubtful accounts                                                |   | (132                               | )      | (449 | ) |
| Deferred  income tax expense                                                    |   | 990                                |   | — |   |
| Loss on  disposition of property, plant and equipment                           |   | 338                                |   | 299 |   |
| Gain on  extinguishment of long-term debt                                       |   | —                             |   | (1,129 | ) |
| Other non-cash  items                                                           |   | 292                                |   | 157 |   |
| Changes in  operating assets and liabilities                                    |   |                               |   |   |   |
| (Increase)  decrease in accounts receivable                                     |   | (6,873                             | )      | 9,473 |   |
| (Increase)  decrease in inventories                                             |   | 3,912                              |   | (3,721 | ) |
| Increase in  other assets                                                       |   | (270                               | )      | (421 | ) |
| Increase  (decrease) in trade accounts payable                                  |   | 850                                |   | (189 | ) |
| Increase  (decrease) in deferred revenue & maintenance contracts deposits   |   | (5,058                             | )      | 11,114 |   |
| Increase in  other accrued expenses and liabilities                             |   | 5,434                              |   | 2,234 |   |
| Cash flows  provided by operating activities                                    |   | 4,856                              |   | 27,763 |   |
|                                                                            |   |                               |   |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES                                           |   |                               |   |   |   |
| Purchases of  property, plant and equipment                                     |   | (3,453                             | )      | (3,255 | ) |
| Proceeds from  sale of property, plant and equipment                            |   | 297                                |   | — |   |
| Cash flows  used in investing activities                                        |   | (3,156                             | )      | (3,255 | ) |
|                                                                            |   |                               |   |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES                                           |   |                               |   |   |   |
| Payments of  current maturities of long-term debt and capital lease obligations |   | (565                               | )      | (599 | ) |
| Payments on  long-term borrowing                                                |   | —                             |   | (2,752 | ) |
| Debt issuance  costs                                                            |   | (50                                | )      | (95 | ) |
| Cash flows  used in financing activities                                        |   | (615                               | )      | (3,446 | ) |
|                                                                            |   |                               |   |   |   |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                        |   | 328                                |   | 320 |   |
| NET INCREASE  IN CASH AND CASH EQUIVALENTS                                      |   | 1,413                              |   | 21,382 |   |
| CASH AND CASH  EQUIVALENTS-BEGINNING OF YEAR                                    |   | 61,566                             |   | 31,595 |   |
|                                                                            |   |                               |   |   |   |
| CASH AND CASH  EQUIVALENTS-END OF PERIOD                                        |   | $                                  | 62,979 |   | $ | 52,977 |   |
|                                                                            |   |                               |   |   |   |
| SUPPLEMENTAL  DISCLOSURES INFORMATION:                                          |   |                               |   |   |   |
| Cash paid  (refunded) during the period for:                                    |   |                               |   |   |   |
| Interest                                                                        |   | $                                  | 8,877  |   | $ | 10,791 |   |
| Taxes                                                                           |   | $                                  | 1,285  |   | $ | (844 | ) |

 

See notes to unaudited condensedconsolidated financial statements.

 

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**BANCTEC,INC.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.****                                      NATURE OF BUSINESS AND BASIS OF PRESENTATION**

 

BancTec, Inc. is a worldwide systems integration and services companywith a 30-year history in imaging technology, financial transaction processingand workflow productivity improvement. Serving a variety of industries, including banking, financial services,insurance, healthcare, governmental agencies and others, the Company offers aportfolio of payment and document processing systems and services, workflow andimage management software products, and computer and network support services.

 

The accompanying unaudited condensedconsolidated balance sheet at June 30, 2004, and the unaudited condensed consolidated statements ofoperations and cash flows for the interim periods ended June 30, 2004 and2003, should be read in conjunction with BancTec, Inc. and subsidiaries(“BancTec” or the “Company”) consolidated financial statements and notesthereto in the most recent Annual Report on Form 10-K filed with the Securitiesand Exchange Commission.   In theopinion of management, the accompanyingcondensed consolidated financial statements contain all materialadjustments, consisting principally of normal recurring adjustments, necessaryfor a fair presentation of the financial position and results of operations ofthe Company. All significant intercompany balances and transactions have beeneliminated in consolidation.

 

**2.****                                      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

The significant accounting principles and practices used in thepreparation of the accompanying financial statements are summarized below:

 

**Cashand Cash Equivalents and Short-Term Investments**

 

Cash and cash equivalents include cash on hand and on deposit,including highly liquid investments with original maturities of three months orless. Short-term investments or similar instruments with original maturities inexcess of three months are valued at cost, which approximates market.Restricted cash at June 30, 2004, of $10.8 million represents the cashpledged under the terms of the Revolver.

 

**Allowancefor Doubtful Accounts**

 

The allowance for doubtful accounts is an estimate prepared bymanagement based on evaluation of the collectibility of specific accounts andthe overall condition of the receivable portfolios. The Company analyzes tradereceivables, and analyzes historical bad debts, customer credits, customerconcentrations, customer credit-worthiness, current economic trends and changesin customer payment terms, when evaluating the adequacy of the allowance fordoubtful accounts. The allowance for doubtful accounts is reviewed periodicallyand adjustments are recorded as deemed necessary.

 

**Inventories**

 

Inventories are valued at the lower of cost or market and include thecost of raw materials, labor, factory overhead, and purchased subassemblies.Cost is determined using the first-in, first-out and weighted average methods.At least quarterly, the Company evaluates the carrying amount of inventorybased on the identification of excess and obsolete inventory. The Company’sevaluation involves a multi-element approach incorporating the stratificationof inventory by time held and the stratification of inventory by risk category,among other elements.  The approachincorporates both recent historical information and management estimates oftrends. The Company’s approach is intended to take into consideration potentialexcess and obsolescence caused by a decreasing installed base, engineeringchanges and end of manufacture.  If anyof the elements of the Company’s estimate were to deteriorate, write-downs maybe required. The inventory write-down calculations are reviewed periodicallyand additional write-downs are recorded as deemed necessary.  Inventory reserves as of June 30, 2004,and December 31, 2003, were $14.6 million and $15.0 millionrespectively.  Inventory reservesestablish a new cost basis for inventory and are not reversed in futureperiods.

 

**Property,Plant, and Equipment**

 

Property, plant, and equipment are recordedat cost and are depreciated or amortized principally on a straight-line basisover the estimated useful lives of the related assets. Estimated useful livesrange from three to five years for field support spare parts, three to eightyears for systems and software, five to seven years for machinery andequipment, leasehold improvements, and furniture and fixtures. Buildings aredepreciated over 40 years.   Depreciationexpense for the six months ended June 30, 2004 and 2003 was $7.8 millionand $10.2 million respectively.

 

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**RevenueRecognition**

 

The Company derives revenue primarily from two sources: 1) productsales- hardware and software which address complex data and paper-intensivework processes, including advanced web-enabled imaging and workflowtechnologies with both BancTec-manufactured equipment and third-partyequipment,  and 2) services- whichconsist primarily of application design, development and maintenance, allaspects of desktop outsourcing, including field engineering, as well as helpdesk and LAN/WAN network outsourcing.

 

The Company applies the provisions of Statement of Position 97-2,“Software Revenue Recognition,” as amended by Statement of Position 98-9“Modification of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions” to all transactions involving the sale of softwareproducts and sales of hardware where the software is not incidental. For thosetransactions that involve acceptance certificates, the Company recognizesrevenue upon receipt of the acceptance certificate, or when it can beobjectively demonstrated that acceptance criteria have been met.  For hardware transactions where software isconsidered incidental, or no software is included, revenue is recognized whenthe product has been delivered and all obligations have been fulfilled.

 

The Company recognizes revenue from sales ofequipment and supplies upon delivery and transfer of title or upon customeracceptance.

 

The Company recognizes hardware and software revenue when persuasiveevidence of an arrangement exists, delivery has occurred, the sales price isfixed or determinable and collectibility is probable. At the time of thetransaction, the Company determines whether the fee associated with revenuetransactions is fixed or determinable and whether or not collection isreasonably assured. The Company determines whether the fee is fixed ordeterminable based on the payment terms associated with the transaction. If asignificant portion of a fee is due after the normal payment terms, which aregenerally 30 days from invoice date, the Company recognizes revenue as the feesare collected. The Company assesses collectibility based on a number of factors,including past transaction history with the customer and the credit-worthinessof the customer. The Company does not request collateral from customers. If theCompany determines that collection of the fee is not reasonably assured, theCompany defers the revenue and recognizes revenue at the time collectionbecomes reasonably assured, which is generally upon receipt of cash. For allsales, the Company generally uses either a binding purchase order or signedsales agreement as evidence of an arrangement.

 

Maintenance contracts are primarily at leastone year in duration and the revenue generated is generally recognized ratablyover the term of the contract.

 

The Company’s services revenue is primarily billed based on contractualrates and terms.  The Company generallyrecognizes revenue as these services are performed which, in some cases isratably over the contract term. Certaincustomers advance funds prior to the performance of the services. TheCompany recognizes revenue related to these advances over time or as servicesare performed on a “per call” basis. These current and non-current portions of these advances are shown asDeferred Revenue or Maintenance Contract Deposits on the Consolidated BalanceSheets.

 

**Researchand Development**

 

Research and development costs are expensedas incurred.   Research and developmentcosts for the six months ended June 30, 2004, and 2003, were $4.6 millionand $7.4 million respectively.

 

**IncomeTaxes**

 

The Company and its domestic subsidiaries file a consolidated federal income tax return with BancTec Intermediate Holding as the parent company. The Company’s foreign subsidiaries file separate income tax returns in the countries in which their operations are based.

 

Income taxes are accounted for under theasset and liability method.  Deferredtax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss and tax credit carryforwards. The Company records valuation allowancesrelated to its deferred income tax assets when, in the opinion of management,it is more likely than not that some portion or all of the deferred income taxassets will not be realized. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date.

 

**ForeignCurrency Translation**

 

Foreign assets and liabilities are translatedusing the exchange rate in effect at the balance sheet date, and results of operationsare translated using an average rate for the period. Translation adjustmentsare accumulated and reported as a component of stockholders’ 

 

6

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deficit and comprehensive income (loss).Transaction gains and losses are included in results of operations in “Sundry,net”.

 

**Stock-BasedCompensation**

 

The Company accounts for stock-basedcompensation using the intrinsic value method prescribed in AccountingPrinciples Board (“APB No. 25”), Accounting for Stock Issued to Employees. TheCompany has adopted the disclosure requirements of Statement of FinancialAccounting Standards (“SFAS No. 123”), Accounting for Stock-Based Compensation.

 

2000 Stock Plan:

 

Effective July 1, 2000, the Companyadopted the 2000 Stock Plan (the Plan), which provides for the grant toemployees of incentive options, non-qualified stock options, and restrictedstock awards.

 

Incentive Options. During the year endedDecember 31, 2003, the Company granted 45,000 incentive options.  During the six months ended June 30,2004, 369,500 incentive options were granted. Under the Plan, incentive options are granted at a fixed exercise pricenot less than 100% of the fair market value of the shares of stock on the dateof grant (or 110% of the fair market value in certain circumstances). A portionof the incentive options vest over a four-year period at 25% per year beginningJanuary 2, 2001; the remainder vest based on the performance of theCompany. As a part of an employee retention program, vesting of 20.0% of theperformance-based incentive options was accelerated in October 2000.

 

Non-qualified stock options. During the yearended December 31, 2003, no non-qualified options were granted.  During the six months ended June 30,2004, the Company granted 50,000 non-qualified stock options.  Under the Plan, non-qualified options aregranted at a fixed exercise price equal to, more than, or less than 100% of thefair market value of the shares of stock on the date of grant. Thenon-qualified options granted in 2000 vest partially over a four-year period at25% per year beginning January 2, 2001; the remainder vest based on theperformance of the Company. As a part of an employee retention program, vestingof 20.0% of the performance-based incentive options was accelerated inOctober 2000.  The non-qualifiedoptions granted in 2004 vest over a three-year period.

 
|                                             |   | **Incentive   Shares** |   | **Non-qualified  Shares** |   | **Weighted   Average   Exercise   Price** |   |
|--------------------------------------------------|--------|------------------------|--------|---------------------------|--------|-------------------------------------------|--------|
| Options  outstanding–December 31, 2002 |   | 497,240                |   | 31,760                    |   | 9.25                                      |   |
| Granted                                          |   | 45,000                 |   | —                    |   | 9.25                                      |   |
| Forfeited                                        |   | (60,000                | )      | —                    |   | 9.25                                      |   |
| Options  outstanding–December 31, 2003 |   | 482,240                |   | 31,760                    |   | 9.25                                      |   |
| Granted                                          |   | 369,500                |   | 50,000                    |   | 9.25                                      |   |
| Forfeited                                        |   | (25,500                | )      | —                    |   | 9.25                                      |   |
| Options  outstanding–June 30, 2004     |   | 826,240                |   | 81,760                    |   | 9.25                                      |   |

 

Options and awards expire and terminate theearlier of ten years from the date of grant or one month after the date theemployee ceases to be employed by the Company.

 

At June 30, 2004, options to purchase908,000 shares were outstanding, of which 266,100 were vested.  All options outstanding have an exerciseprice of $9.25.  No options have beenexercised.

 

Under the intrinsic-value method,compensation expense is recorded only to the extent that the strike price isless than market price on the measurement date.  All options granted in 2003 and 2004 were issued at or abovemarket price, and therefore no stock-based compensation was recorded.

 

The following table illustrates the effect onnet income as if compensation for the Company’s stock option plans had beendetermined in conformance with SFAS No. 123:

 

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|                                                                                                                  |   | **Six Months Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                                  |   | **2004**                           |   | **2003** |   |
| Net income  (loss) as reported                                                                                        |   | $                                  | (2,471 | ) | $ | 157 |   |
| Total stock-based employee compensation  expense determined under fair-value-based method for all rewards, net of tax |   | (39                                | )      | — |   |
| Pro Forma net  income (loss)                                                                                          |   | $                                  | (2,510 | ) | $ | 157 |   |

 

**3.****                                      RECLASSIFICATION, IMPAIRMENT AND CHANGE INACCOUNTING ESTIMATE**

 

## *Reclassification*

Certain amounts have been reclassified fromthe prior years to conform to the current year presentation.

 

The Company has two issues of Preferred Stock as described in Note 14 –Preferred Stock, contained in Notes to the Condensed Consolidated FinancialStatements.  Series A Preferred Stock hasbeen historically classified in the mezzanine section of the ConsolidatedBalance Sheets due to the provision providing for mandatory redemption.  On March 31, 2004, the Board ofDirectors and the holder of the Series A Preferred Stock approved an amendmentto the Series A Preferred Stock agreement to remove the mandatory redemptionprovision.

 

Both the Series A Preferred and the Series B Preferred includeprovisions for redemption at the option of holders in certain circumstancesincluding a sale or merger of the Company and redemption at the option of theCompany.  At December 31, 2003, theSeries B Preferred was classified in the mezzanine section as provided byguidance contained in EITF Topic D-98, “Classification and Measurement ofRedeemable Securities.”  Under thisguidance, classification in the permanent equity section is not consideredappropriate if the preferred stock is redeemable upon majority vote of theBoard of Directors and such board is controlled by the preferred securityholders.  At December 31, 2003,preferred security holders comprised 50% of the Board of Directors.  On March 31, 2004, the Board ofDirectors elected a seventh member who is not a preferred security holder.  As a result of the removal of the mandatoryredemption provisions for Series A Preferred Stock and the addition of theseventh board member whereby the preferred security holders no longer controlthe Board of Directors, the Series A and Series B Preferred Stock are beingreclassified into the permanent equity section of the Consolidated BalanceSheets at June 30, 2004.

 

## *Impairment*

The Company’s investments in non-marketable equity securities ismonitored for impairment and is written down to fair value with a change toearnings if a decline in fair value is judged to be other than temporary.  During the second quarter of 2004, theCompany recorded a write down of approximately $1.5 million to reflect theestimated fair value of $2.7 million in its investment in the stock of ServibancaS.A. (43.4% interest), which is accounted for as an equity investment.  The sale of this stock, at a net sales priceof $2.7 million is expected to be completed in August 2004.  The impairment charge of $1.5 million isreflected in Sundry, net in the Condensed Consolidated Statements ofOperations.

 

## *Changein Accounting Estimate*

During the quarter ended June 30, 2004, the Company recordedrevenue of $4.3 million reflecting an adjustment arising out of a change inaccounting estimate related to deferred revenue.  The recording of deferred revenue requires the use of certainestimates, and new facts came to the attention of the Company, whichnecessitated the change in these estimates.

 

**4.****                                      SUPPLEMENTAL SCHEDULE OF NONCASH INVESTINGAND FINANCING TRANSACTIONS**

 

The Consolidated Statement of Cash Flowsincluded the following noncash investing and financing transactions:

 
|                                                              |   | **Six Months  Ended June 30,** |   |
|-------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                              |   | **2004**                            |   | **2003** |   |
|                                                              |   | **(In  thousands)**                 |   |
| Capital lease obligation incurred for lease  of computer hardware |   | $                                   | 241    |   | $ | 2,048 |   |
| Inventory put in service as fixed asset                           |   | 105                                 |   | 1,857 |   |
|                                                                   |        |                                     |        |  |  |  |  |

 

8

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**5.****                                      INVENTORIES**

 

Inventory consists of the following: 
|             |   | **June 30,  2004** |   | **December 31,  2003** |   |
|------------------|--------|-------------------------|--------|-----------------------------|--------|
|             |   | **(In thousands)**      |   |
| Raw materials    |   | $                       | 9,921  |                        | $      | 6,035 |   |
| Work-in-progress |   | 5,580                   |   | 7,168                       |   |
| Finished goods   |   | 4,410                   |   | 10,705                      |   |
|             |   | $                       | 19,911 |                        | $      | 23,908 |   |

 

**6.****                                      PROPERTY, PLANT AND EQUIPMENT**

 

Property, plant and equipment consist of thefollowing:

 
|                                       |   | **June 30,  2004** |   | **December 31,  2003** |   |
|--------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                       |   | **(In thousands)**      |   |
| Land                                       |   | $                       | 2,860  |                        | $      | 2,860 |   |
| Field support  spare parts                 |   | 59,332                  |   | 59,789                      |   |
| Systems and  software                      |   | 58,962                  |   | 58,927                      |   |
| Machinery and  equipment                   |   | 21,003                  |   | 21,075                      |   |
| Furniture,  fixtures and other             |   | 19,251                  |   | 19,514                      |   |
| Buildings                                  |   | 27,676                  |   | 27,653                      |   |
|                                       |   | 189,084                 |   | 189,818                     |   |
| Accumulated  depreciation and amortization |   | 149,175                 |   | 144,986                     |   |
| Property,  plant and equipment, net        |   | $                       | 39,909 |                        | $      | 44,832 |   |

 

**7.****                                      OTHER ACCRUED EXPENSES AND LIABILITIES**

 

Other accrued expenses and liabilitiesconsist of the following:

 
|                                    |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-----------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                    |   | **(In thousands)**      |   |
| Salaries,  wages and other compensation |   | $                       | 15,265 |                        | $      | 12,843 |   |
| Accrued taxes,  other than income taxes |   | 4,398                   |   | 5,312                       |   |
| Advances from  customers                |   | 6,117                   |   | 907                         |   |
| Accrued  interest payable               |   | 3,205                   |   | 3,211                       |   |
| Accrued  invoices and costs             |   | 1,204                   |   | 2,114                       |   |
| Other                                   |   | 13,397                  |   | 12,514                      |   |
|                                    |   | $                       | 43,586 |                        | $      | 36,901 |   |

 

9

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**8.****                                      DEBT AND OTHER OBLIGATIONS**

 

Debt and other obligations consist of thefollowing:

 
|                                          |   | **June 30,  2004** |    | **December 31,  2003** |   |
|-----------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                          |   | **(In thousands)**      |    |
| 7.5% Senior  Notes, secured, due 2008         |   | $                       | 93,975  |                        | $      | 93,975 |   |
| Sponsor Note,  unsecured, due 2009            |   | 103,848                 |    | 103,848                     |   |
| Revolving  Credit Facility, secured, due 2006 |   | —                  |    | —                      |   |
|                                          |   | 197,823                 |    | 197,823                     |   |
| Less:  Current portion                   |   | —                  |    | —                      |   |
|                                          |   | $                       | 197,823 |                        | $      | 197,823 |   |

 

Revolving Credit Facility.  TheCompany has a revolving credit facility (the “Revolver”) provided by HellerFinancial, Inc. (“Heller”), which matures on May 30, 2006.  Effective May 7, 2003, the Companyand Heller entered into an amendment to the Revolver which reduced thecommitted amount from $60 million to $40 million, while increasing theletter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.   Fundsavailability under the Revolver is determined by a borrowing-base formula equalto a specified percentage of the value of the Company’s eligible accountsreceivable, inventory and pledged cash. At June 30, 2004, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $10.7million.  The balance remaining underthe Revolver that the Company can draw was $16.4 million at June 30, 2004($20.4 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Under an amendment effectiveSeptember 1, 2003, the interest rate margins over prime and LIBOR may beincreased by 0.25% increments when the fixed charge coverage ratio falls below(1) 2.0 to 1.0, (2) 1.75 to 1.0, (3) 1.5 to 1.0 and (4) 1.25 to 1.0 and (totalrate increase of 1.00%) or decreased by 0.25% increments when the fixed chargecoverage ratio is greater than 2.25 to 1.0 (total rate decrease of 0.25%).  At June 30, 2004, the Company’s rate onthe Revolver was 5.0%.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at June 30, 2004 of $10.8 million represents cashpledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties andcovenants, including financial covenants as to maximum capital expenditures,minimum fixed charge coverage ratio and minimum average borrowingavailability.  At June 30, 2004,the Company was in compliance with all covenants under the Revolver.

 

Senior Notes. Interest on the Senior Notes is fixed at 7.5% and is due and payable insemi-annual installments. Payments began December 1, 1998. The Notescontain covenants placing limitations on the Company’s ability to permitsubsidiaries to incur certain debts, incur certain loans, and engage in certainsale and leaseback transactions. During thefirst six months of 2003, the Company repurchased Senior Notes with a faceamount of $3.9 million. The Company wrote off a proportionate share of deferredfinancing-fees, resulting in a gain of approximately $1.1 million, which wasreported as sundry (other) income in the condensed consolidatedstatements of operations for the interim period ended June 30, 2003.  Theestimated fair value of the Senior Notes as of June 30, 2004, isapproximately $66.9 million based on an average value of the most recentlycompleted market trades, resulting in a yield-to-maturity of approximately18%.  The number of actual trades islimited; therefore the result may vary if a widely traded market environmentexisted.

 

Unsecured Sponsor Note. The Company’s SponsorNote bears interest at 10.0%, due and payable quarterly. The Sponsor Note issubordinate only upon bankruptcy or insolvency of the Company, or if uponmaturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999.As provided under the agreement, however, the Sponsor Note holder, Welsh,Carson, Anderson & Stowe (“WCAS’), elected to defer quarterly interestpayments of $4.0 million for each of the September 2000 

 

10

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through September 2001 quarterly periods resulting in an increasein the principal amount of the Sponsor Note totaling $33.8 million.  Such election required a deferredfinancing-fee of 30.0% of each of the interest payments being deferred.  The Company accounts for the additionalfinancing fees as a change in the effective interest rate of the debt. WCASmay, at its election, defer each future quarterly payment under similarterms.  WCAS has not elected to deferthe quarterly payments since September 2001.  In accordance with the terms of the Sponsor Note, on December 6,2002, the Company made a $90.0 million principal payment on the Sponsor Note.  A holder of the Senior Notes had sought tocontest this payment.  See discussionunder Legal Proceedings.  The estimatedfair-value of the Sponsor Note and deferred interest and fees as ofJune 30, 2004, is approximately $64.4 million assuming a yield-to-maturityof 23%.

 

The Company had no outstanding balances onforeign credit agreements at June 30, 2004.

 

Capital Leases.  During the first quarter of 2003, the Company entered into acapital lease for $2.0 million that pertained to computer hardware.  Amounts due under capital leases are recordedas liabilities. The Company’s interest in assets acquired under capital leasesis recorded as property and equipment on the Condensed Consolidated BalanceSheets. Amortization of assets recorded under capital leases is included indepreciation expense.  The currentportion of obligations under capital leases are classified in the currentliabilities section of the Condensed Consolidated Balance Sheets and thenon-current portion of capital leases are included in Other Liabilities.

 

**9.****                                      GOODWILLAND INTANGIBLE ASSETS**

 

Beginning January 1, 2002, the Companyadopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwilland Other Intangible Assets” (See “New Accounting Pronouncements”).  SFAS No. 142 requires that goodwill andintangible assets with indefinite useful lives no longer be amortized butinstead be tested for impairment at least annually.  SFAS No. 142 also requires that intangible assets with definiteuseful lives be amortized over their respective estimated useful lives to theirestimated residual values.

 

SFAS No. 142 requires a two-step process for testing impairment. First,the fair value of each reporting unit is compared to its carrying value todetermine whether an indication of impairment exists. If impairment isindicated, then under the second step the fair value of the reporting unit’sgoodwill is determined by allocating the unit’s fair value to its assets andliabilities (including any unrecognized intangible assets) as if the reportingunit had been acquired in a business combination. The amount of impairment forgoodwill is measured as the excess of its carrying value over its fair value.

 

Goodwill previously classified as unallocated has been allocated to thereporting units as required by SFAS No. 142. There were no changes in thecarrying amount of goodwill by segment for the six months ended June 30,2004 or June 30, 2003.

 

**10.****                               TAXES**

 

The tax effects of temporary differences thatgive rise to significant portions of the deferred tax assets and liabilitiesare presented below (dollars in thousands):

 
|                                            |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                            |   | **(In thousands)**      |   |
| Gross deferred  tax assets:                     |   |                    |   |                        |   |
| Net operating  losses                           |   | $                       | 34,071 |                        | $      | 38,106 |   |
| AMT credit  carryforwards                       |   | 485                     |   | 328                         |   |
| Inventory  reserves                             |   | 5,249                   |   | 5,360                       |   |
| Receivable  allowance                           |   | 185                     |   | 301                         |   |
| Intangible  assets previously deducted          |   | 1,123                   |   | 1,341                       |   |
| Deferred  revenues                              |   | 24,830                  |   | 23,152                      |   |
| Deferred  compensation                          |   | 3,211                   |   | 2,443                       |   |
| Foreign timing  differences, net                |   | 3,802                   |   | 3,835                       |   |
| Taxes paid on  intercompany profits             |   | 1,034                   |   | 938                         |   |
| Other                                           |   | 5,003                   |   | 5,129                       |   |
| Total gross  deferred tax asset                 |   | 78,993                  |   | 80,933                      |   |
| Gross deferred  tax liabilities:                |   |                    |   |                        |   |
| Depreciation                                    |   | (1,628                  | )      | (1,646                      | )      |
| Undistributed  earnings of foreign subsidiaries |   | (5,837                  | )      | —                      |   |
| Other                                           |   | (156                    | )      | (679                        | )      |
| Total gross  deferred tax liability             |   | (7,621                  | )      | (2,325                      | )      |
| Deferred tax  asset valuation reserve           |   | (58,566                 | )      | (64,812                     | )      |
| Net deferred  tax asset                         |   | $                       | 12,806 |                        | $      | 13,796 |   |

 

11

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A valuation allowance has been provided to reduce the deferred taxassets to an amount management believes is more likely than not to be realized.Expected realization of deferred tax assets for which a valuation allowance hasnot been recognized is based upon the reversal of existing taxable temporarydifferences and taxable income expected to be generated in the future.  The valuation allowance for deferred taxassets as of June 30, 2004 and December 31, 2003 was $58,566,000 and$64,812,000, respectively.  The netchange in the total valuation allowance for the six months ended June 30,2004 was a decrease of $6,246,000, consisting of a $5,837,000 decrease relatedto the recorded of a deferred tax liability on the undistributed earnings oftwo foreign subsidiaries, and a decrease of $409,000 related to continuingoperations.

 

Undistributed earnings of foreignsubsidiaries included in continuing operations were approximately $32.4 and$35.9 million at June 30, 2004 and December 31, 2003, respectively.Taxes have been provided on the undistributed earnings of two subsidiaries,BancTec Limited and BancTec Holding N.V., as specified by APB 23, “Accountingfor Income Taxes—Special Areas,” due to the distribution of dividends fromthese subsidiaries during the six months ended June 30 2004.  No taxes have been provided for the othersubsidiaries as they are considered to be permanently reinvested.

 

**11.****                              ****WARRANTYLIABILITY**

 

The Companyoffers various product warranties for hardware sold to its customers.  Thespecific terms and conditions of the warranties vary depending upon thecustomer and the product sold.  Factors that affect the Company’s warrantyliability include number of products sold, historical and anticipated rates ofwarranty claims and cost per claim.  The Company accrues for estimatedwarranty costs as sales are made and periodically assesses the adequacy of itsrecorded warranty liability and adjusts the amount as necessary.

 

Changes tothe Company’s warranty liability, which is reported as a component of otheraccrued expenses and liabilities in the accompanying condensed consolidatedbalance sheet during the six months ended June 30, 2004 are summarized asfollows:

 
|                                              |   | **(In  thousands)** |   |
|---------------------------------------------------|--------|---------------------|--------|
| Balance at December 31, 2003                 |   | $                   | 140    |   |
| Warranties issued                                 |   | 90                  |   |
| Claims paid/settlements                           |   | (67                 | )      |
| Changes in liability for pre-existing  warranties |   | —              |   |
| Balance at June 30, 2004                     |   | $                   | 163    |   |

 

12

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**12.****                               COMPREHENSIVELOSS**

 

The components of comprehensive income (loss) were as follows:

 
|                                     |   | **Three Months  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                     |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                     |   | **(In  thousands)**                   |   | **(In  thousands)**                 |   |
| Net income (loss)                        |   | $                                     | (1,679 | )                                   | $      | 303 |   | $ | (2,471 | ) | $ | 157 |   |
| Foreign currency translation adjustments |   | (151                                  | )      | 740                                 |   | 312 |   | 637 |   |
| Total comprehensive income (loss)        |   | $                                     | (1,830 | )                                   | $      | 1,043 |   | $ | (2,159 | ) | $ | 794 |   |

 

13

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**13.****                               BUSINESS SEGMENT DATA**

 

The Company segments its operations based on geographical areas  (U.S. Solutions (“USS”) and InternationalSolutions (“INTL”)) and product lines (Computer and Network Services (“CNS”)).INTL offers similar products as USS and consists primarily of operationsthroughout the world excluding the United States.

 
|                                           |   | **US   Solutions** |   | **Computer   & Network  Services** |   | **International** |   | **Corp/Elims** |   | **Total** |   |
|------------------------------------------------|--------|--------------------|--------|----------------------------------------|--------|-------------------|--------|----------------|--------|-----------|--------|
|                                           |   | **(In thousands)** |   |
| For the three  months ended June 30, 2004 |   |               |   |                                   |   |              |   |           |   |      |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers               |   | $                  | 31,218 |                                   | $      | 33,735            |   | $              | 34,866 |      | $      | — |   | $ | 99,819 |   |
| Intersegment  revenue                          |   | 726                |   | —                                 |   | 1,855             |   | (2,581         | )      | —    |   |
| Segment gross  profits                         |   | 6,516              |   | 5,419                                  |   | 12,265            |   | 176            |   | 24,376    |   |
| Segment  operating income (loss)               |   | 1,375              |   | 3,265                                  |   | 5,394             |   | (2,297         | )      | 7,737     |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| For the three  months ended June 30, 2003 |   |               |   |                                   |   |              |   |           |   |      |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers               |   | $                  | 38,591 |                                   | $      | 32,947            |   | $              | 25,505 |      | $      | — |   | $ | 97,043 |   |
| Intersegment  revenue                          |   | 562                |   | —                                 |   | 1,868             |   | (2,430         | )      | —    |   |
| Segment gross  profits                         |   | 8,613              |   | 6,895                                  |   | 9,110             |   | 265            |   | 24,883    |   |
| Segment  operating income (loss)               |   | 2,378              |   | 4,644                                  |   | 2,010             |   | (3,272         | )      | 5,760     |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| For the six  months ended June 30, 2004   |   |               |   |                                   |   |              |   |           |   |      |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers               |   | $                  | 60,150 |                                   | $      | 65,351            |   | $              | 63,402 |      | $      | — |   | $ | 188,903 |   |
| Intersegment  revenue                          |   | 1,472              |   | —                                 |   | 3,963             |   | (5,435         | )      | —    |   |
| Segment gross  profits                         |   | 13,830             |   | 6,868                                  |   | 23,266            |   | (244           | )      | 43,720    |   |
| Segment  operating income (loss)               |   | 3,496              |   | 2,734                                  |   | 9,447             |   | (3,973         | )      | 11,704    |   |
| Segment  identifiable assets                   |   | 76,967             |   | 24,784                                 |   | 55,655            |   | 80,937         |   | 238,343   |   |
| Capital  appropriations                        |   | 1,213              |   | 1,107                                  |   | 1,013             |   | 466            |   | 3,799     |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| For the six  months ended June 30, 2003   |   |               |   |                                   |   |              |   |           |   |      |   |
|                                           |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers               |   | $                  | 70,614 |                                   | $      | 63,767            |   | $              | 53,414 |      | $      | — |   | $ | 187,795 |   |
| Intersegment  revenue                          |   | 1,106              |   | —                                 |   | 3,070             |   | (4,176         | )      | —    |   |
| Segment gross  profits                         |   | 15,697             |   | 12,862                                 |   | 18,537            |   | 275            |   | 47,371    |   |
| Segment  operating income (loss)               |   | 2,625              |   | 8,477                                  |   | 4,361             |   | (5,656         | )      | 9,807     |   |
| Segment  identifiable assets                   |   | 100,006            |   | 28,518                                 |   | 53,644            |   | 61,121         |   | 243,289   |   |
| Capital  appropriations                        |   | 1,349              |   | 587                                    |   | 2,761             |   | 2,463          |   | 7,160     |   |

 

**14.          PREFERRED STOCK**

 

**SERIESA PREFERRED STOCK**

 

The Company allocated the proceeds from its Series A preferred stockissuance based upon the relative fair value of the preferred stock and warrantsissued.  The related discount is beingaccreted over a period of 8 years.  Forthe six months ended June 30, 2004, accretion of the related discount andaccrued but unpaid dividends totaled $0.9 million, increasing the carryingamount to $17.5 million. As of June 30, 2004, the stated value of theSeries A preferred stock, including accumulated but unpaid dividends, was$194.40 per share.

 

**SERIES B PREFERREDSTOCK**

 

For the six months ended June 30, 2004, the Company accruedadditional unpaid dividends for its Series B preferred stock totaling $1.4million, increasing the carrying amount to $12.0 million.  As of June 30, 2004, the stated valueof the Series B preferred stock, including accumulated but unpaid dividends,was $336.83 per share.

 

14

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**15.****                               RECENT ACCOUNTING PRONOUNCEMENTS**

 

In June 2003, the FASB issued SFAS No. 150, “Accounting forCertain Financial Instruments with Characteristics of Both Liabilities andEquity.” The statement is effective for financial instruments entered into ormodified after May 31, 2003, and otherwise is effective at the beginning of thefirst interim period beginning after June 15, 2003, except for mandatorilyredeemable financial instruments of a nonpublic entity.  For mandatorily redeemable financialinstruments of a nonpublic entity, this statement shall be effective for fiscalperiods beginning after December 15, 2003.  The Company has adopted SFAS No. 150 with no effect on theCompany’s results of operations or financial position.

 

**16.   SUBSEQUENT EVENTS**

 

None

 

15

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**ITEM2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND**

**RESULTSOF OPERATIONS.**

 

THE FOLLOWING DISCUSSION SHOULD BE READ INCONJUNCTION WITH THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND THERELATED NOTES THAT APPEAR ELSEWHERE IN THIS DOCUMENT.

 

**FORWARD-LOOKING STATEMENTS**

 

*This Quarterly Report on Form10-Q, including Management’s Discussion and Analysis of Financial Condition andResults of Operations and Quantitative and Qualitative Disclosure About MarketRisk, contains forward-looking statements as that term is defined in thePrivate Securities Litigation Reform Act of 1995 (the “PSLRA”) that involverisks and uncertainties, as well as assumptions that, if they never materializeor prove incorrect, could cause the results of BancTec, Inc. and itsconsolidated subsidiaries (the “Company”) to differ materially from thoseexpressed or implied by such forward-looking statements. All statements otherthan statements of historical fact could be deemed forward-looking statements,including any projections of earnings, revenues, or other financial items; anystatements of the plans, strategies, and objectives of management for futureoperations; any statements concerning proposed new products, services, ordevelopments; any statements regarding future economic conditions orperformance; statements of belief and any statement of assumptions underlyingany of the foregoing. The risks, uncertainties and assumptions referred toabove include technological improvements that reduce the market forpaper-handling products, the ability of the Company to retain and motivate keyemployees; the timely development, production and acceptance of products andservices and their feature sets; the challenge of managing asset levels, includinginventory; the flow of products into third-party distribution channels; thedifficulty of keeping expense growth at modest levels while increasingrevenues; and other risks that are described from time to time in the Company’sSecurities and Exchange Commission reports, including but not limited to theitems discussed in “Factors Affecting the Company’s Business and Prospects” setforth in this report, and items described in the Company’s other filings withthe Securities and Exchange Commission. The Company undertakes no obligation toupdate or revise forward-looking statements to reflect changes in assumptions,the occurrence of unanticipated results or changes to future operating resultsover time.*

 

**Overview**

 

The Company believes several factors continued to create a challengingand competitive sales and cost-containment environment during the six monthsended June 30, 2004.  These factorsinclude: the impact of check truncation, reduced corporate customer technologyspending; ongoing competitive pressures; an ongoing planned change in revenuemix within the Company’s U.S. Solutions (“USS”) and International Solutions(“INTL”) segments; and a highly leveraged financial position.  The change in revenue mix is partially aresult of trends in payment processing, including truncation, which impactsdomestic and international markets. Additionally, during the six months ended June 30, 2004, the USSand INTL segments experienced revenue declines in the maintenance business, theduration of which the Company cannot predict.

 

Computer and Network Services (“CNS”) encounters aggressive competitionfrom a variety of companies.  TheCompany believes that functionality, quality, and price of its serviceofferings are important competitive factors in the markets in which itoperates.  While the Company believesthat its offerings compete favorably based on each of these elements, theCompany could be adversely affected if its competitors offer such service undermore attractive terms than the Company. The CNS division recently amended or terminated certain unprofitablecustomer contracts.

 

Expected economic and business conditions into the remainder of 2004indicate a cautious outlook regarding the Company’s near-term revenue andearnings growth prospects.  In the USSdivision, the passage of the Check Clearing for the 21st Century Act (“Check21”), to allow for the truncation of checks, is expected to result in decreaseddemand for payment and check clearing solutions.  The Company has concentrated on cost reductions and on documentprocessing solutions. Product-development efforts are being focused on document processingtechnologies, including Electronic Document Management (“EDM”) verticalsolutions and high-speed, full-page scanners, as well as continued hardware enhancements.By incorporating more third-party products into the Company’s solutions ratherthan developing the products, the Company can more easily target its effortsand expenditures to these core products and solutions.

 

**RESULTSOF OPERATIONS**

 

**Comparisonof Three Months Ended June 30, 2004 and Three Months Ended June 30,2003**

 

Consolidated revenue of $99.8 million for thethree months ended June 30, 2004 was an increase of $2.8 million or 2.9%from the comparable prior-year period. The USS revenue decrease of $7.4 million was partially related to adecline in maintenance revenue due to the Company’s installed products reachingthe end of their useful lives and from increased competition.  The Company expects these trends to continuein the foreseeable future.  In addition,a decline in revenue related to the sale and installation of hardware andsoftware products was primarily related to a weak market for payments solutionsdue market trends, including reduced check volume, check truncation, and therecent passage of Check 21.  Increasesin INTL of $9.4 million are the result the impact of the weakening dollar onthe conversion of revenue stated in foreign currencies and the continued growthof document processing services in the United Kingdom.  Although CNS increased $0.8 million with thecomparable prior-year period, revenue of $4.3 million was recorded 

 

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reflecting an adjustment arising out of achange in accounting estimate related to deferred revenue.  Additional revenue increases related to theexpansion by CNS of operations into Europe. Offsetting these increases were revenue decreases resulting from pricingdecreases, domestic competitive pressure, and decreased volume under certainmaintenance programs.  Factors expectedto impact future revenue include corporate-customer spending for largesystems-solutions, the continued impacts of check truncation, customer andprospective customer mergers, on-going competitive pressures, and fluctuationsin international currencies.

 

Consolidated gross profit of $ 24.4 million decreased by $0.5 millionor 2.0% from the comparable prior-year period. Decreases in CNS of $1.5 millionand USS of $2.1 million were partially offset by increases in INTL of $3.2 million.The decrease in USS gross profit resulted primarily from decreasedrevenues.  In addition, the USS grossmargin percentage decreased from 22.3% to 20.9%, resulting from competitivepricing pressures.  Increases in INTLgross profit resulted from increased revenue, including the impact of currencyconversion, partially offset by a lower gross profit percentage, decreasingfrom 35.7% to 35.2%.  CNS’ gross profitpercentage decreased from 20.9% to 16.1%, resulting primarily from decreasedrevenue, margin reduction caused by competitive pricing pressure and lossesexperienced under certain service contracts. CNS is the major component in the maintenance and other servicescategory on the Consolidated Statements of Operations, and therefore is theprimary contributing factor in the decreased gross profit in the maintenanceand other services category.

 

Operating expenses of $16.6 million decreased $2.5 million compared tothe prior-year period. Operating expenses, by component, changed as follows:Product-development expenses decreased by $1.6 million or 43.2% primarily dueto the focused realignment of research and development expenditures againstfuture product strategies and marketing plans. The use of outsourced product-development services also contributed tothe reduction. Selling, general and administrative expenses (“SG&A”)decreased by $0.9 million or 5.8% due to decreased SG&A depreciationexpense and on-going efforts to realign the cost structure.

 

Interest expense for the three months ended June 30, 2004 of  $4.7 million decreased $0.1 million from thecomparable prior-year period.

 

Sundry items resulted in a net loss of $1.5 million during the threemonths ended June 30, 2004.  This loss is a result of the write down ofthe Company’s investment in the stock of Servibanca S.A. to fair market valueat June 30, 2004.  The Company isexpecting to complete the sale of 100% of its holdings in Servibanca S.A. inAugust 2004, for a net sales price of $2.7 million.  This is compared to a net income of$0.2 million recorded during the comparableprior-year period, consisting primarily of foreign-exchange gains.

 

An income tax provision of $3.3 million for the three months endedJune 30, 2004 is compared to acorresponding prior-year period income tax provision of $1.2 million.  The income tax provisions for the prior-yearperiod related primarily to income from the Company’s internationalsubsidiaries.  During the fiscal yearended December 31, 2003, a $13.8 million release of valuation allowancewas recorded to adjust the deferred taxassets to an amount management believes is more likely than not to be realized.  During the first quarter of 2004, theCompany recorded a net loss in the United States and therefore recorded a netdeferred tax benefit.  However theCompany has determined that no tax benefit should be recorded for the sixmonths ended June 30, 2004, and has therefore reversed the first quarterdeferred tax benefit in the second quarter of 2004.  In addition, the Company has recorded an income tax provision ofapproximately $1.4 million during the second quarter of 2004 related primarilyto income of approximately $4.5 million from the Company’s internationalsubsidiaries.  The Company’s effectivetax rate was approximately 204.2% for the three months ended June 30, 2004 as compared to 79.3% for thecorresponding prior-year period.

 

**Comparisonof Six Months Ended June 30, 2004 and Six Months Ended June 30, 2003**

 

Consolidated revenue of $188.9 million forthe six months ended June 30, 2004 increased by $1.1 million or 0.6% fromthe comparable prior-year period. The USS revenue decrease of $10.5 million waspartially related to a decline in maintenance revenue due to the Company’sinstalled products reaching the end of their useful lives and from increasedcompetition.  The Company expects thesetrends to continue in the foreseeable future. In addition, a decline in revenues related to the sale and installationof hardware and software products was primarily related to a weak market forpayments solutions due to market trends, including reduced check volume, checktruncation, and the recent passage of Check 21.  Increases in INTL of $10.0 million are the result of the impactof the weakening dollar on the conversion of revenue stated in foreigncurrencies and the continued growth in the United Kingdom of documentprocessing services.  An increase in CNSof $1.6 million resulted from the revenue adjustment of $4.3 million reflectinga change in accounting estimate related to deferred revenue.  In addition revenue increases resulted fromthe expansion by CNS of operations into Europe.  These increases were somewhat offset by pricing decreases,domestic competitive pressure, and decreased volume under certain maintenanceprograms.  Factors expected to impact futurerevenue include corporate-customer spending for large systems-solutions, thecontinued impacts of check truncation, customer and prospective customermergers, on-going competitive pressures, and fluctuations in internationalcurrencies.

 

Consolidated gross profit of $43.7 milliondecreased by $3.7 million or 7.8% from the comparable prior-year period.Decreases in CNS of $6.0 million and USS of $1.9 million were partially offsetby increases in INTL of $4.7 million. The decrease in USS resulted from decreased revenues, although somewhatoffset by ongoing cost containment efforts resulting in an increase in the USSgross margin percentage from 22.2% to 23.0%. Increases in INTL gross profit resulted partially from increasedrevenue, including the 

 

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impact of currency conversion, and partially from a higher gross profitpercentage, increasing from 32.8% to 34.5%. Continued efforts to provide provendeliverables as well as targeted new offerings, including EDM solutions,archive solutions and hardware enhancements, which, along with ongoingcost-containment efforts, allowed for cost reductions to strengthen the INTLgross profit.  CNS’ gross profitpercentage decreased from 20.2% to 10.5%, resulting primarily from decreasedrevenue, margin reduction caused by competition pricing pressure and lossesexperienced under certain service contracts. CNS is the major component in the maintenance and other services categoryon the Consolidated Statements of Operations, and therefore is the primarycontributing factor in the decreased gross profit in the maintenance and otherservices category.

 

Operating expenses of $32.0 million decreased $5.6 million compared tothe prior-year period. Operating expenses, by component, changed as follows:product-development expenses decreased by $2.8 million or 37.8% primarily dueto the focused realignment of research and development expenditures againstfuture product strategies and marketing plans. The use of outsourced product-development services also contributed tothe reduction. SG&A decreased by $2.7 million or 8.9% due to decreasedSG&A depreciation expense and on-going efforts to realign the coststructure.

 

Interest expense for the six months ended June 30, 2004 of  $9.6 million decreased $0.1 million from thecomparable prior-year period.

 

Sundry items resulted in a net loss of $2.0 million during the sixmonths ended June 30, 2004compared to a net income of $1.4 million during the comparable prior-year period. This decrease is primarily due to foreign-exchange losses of $0.5million and the $1.5 million write down of the Company’s investment in thestock of Servibanca S.A. to fair market value during the current-year period,compared to a gain from the repurchase of Senior Notes of approximately $1.1million and foreign-exchange gains of $0.3 million in the prior-year period.

 

An income tax provision of $2.9 million for the six months endedJune 30, 2004 is compared to acorresponding prior-year period income tax provision of $1.8 million.  The income tax provision for the periodrelated primarily to income of approximately $7.9 million from the Company’sinternational subsidiaries.  The Company’seffective tax rate was approximately (650.3)% for the six months ended June 30, 2004 as compared to 91.9% for thecorresponding prior-year period.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

The Company’s working capital requirements are generally provided bycash and cash equivalents, funds available under the Company’s revolving creditagreement, as discussed below, which matures May 30, 2006, and by internallygenerated funds from operations. Funds availability under the revolving creditagreement is determined by a borrowing-base formula equal to a specifiedpercentage of the value of the Company’s eligible accounts receivable,inventory and pledged cash.  Generaleconomic conditions, the current weakness in demand for the Company’s systemssolutions products and the requirement to obtain performance bonds or similarinstruments could have an impact on the Company’s future liquidity.

 

The Company’s cash and cash equivalents totaled $63.0 million atJune 30, 2004 compared with $61.6 million at December 31, 2003.Working capital increased $3.7 million during the six months ended June 30,2004 to working capital of $13.6 million compared to working capital of $9.9million at December 31, 2003.  Thechange in working capital included a current liability increase of $2.9 millionfrom increased accrued expenses and accounts payable partially offset bydecreases in deferred revenue and maintenance contract deposits, a decrease innet inventories of $4.0 million, an accounts receivable increase of $7.0million and a prepaid expense increase of $2.2 million.

 

During the six months ended June 30, 2004, the Company reliedprimarily on cash flows generated from operating activities to fund operations.At June 30, 2004, the Company had available $20.4 million of borrowingcapacity under the Revolver, of which the Company can draw $16.4 million.

 

Operating activities provided $4.9 million and $27.8 million of cash inthe six months ended June 30, 2004 and 2003, respectively, a decreaseof  $22.9 million.  This decrease resulted from a decrease incash generated by changes in working capital assets and liabilities of $20.5million, a net income decrease of $2.6 million from the prior-year period, anddecreased adjustments from noncash activity including lower depreciationexpense and an increased deferred tax benefit.

 

Investing activities used net cash of $3.2 million and $3.3 million inthe six months ended June 30, 2004 and 2003, respectively. Both uses ofcash related to purchases of property, plant and equipment.

 

Financing activities used $0.6 million and $3.4 million of net cash inthe six months ended June 30, 2004 and 2003, respectively.  Both uses of cash related primarily to thereduction of the Company’s debt.

 

At June 30, 2004, the Company’s principal outstanding debtinstruments consisted of (i) no balance outstanding under the revolving creditfacility maturing May 30, 2006 (which is more fully described below), (ii)  $94.0 million of 7.5% Senior Notes due 2008,and 

 

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(iii) $103.8 million of Sponsor Notes due 2009. The Company or itsaffiliates may from time to time purchase, redeem or pay deferred interest onsome of its outstanding debt or equity securities.  The Company would only make these payments in compliance with thecovenants of its debt instruments.

 

The Company continually reviews its various lines of business to assesstheir contribution to the Company’s business plan and from time to timeconsiders the sale of certain assets in order to raise cash or reducedebt.  Accordingly, the Company fromtime to time has explored and may explore possible asset sales by seekingexpressions of interest from potential bidders.  However, the Company has not entered into any binding agreementsor agreements in principle to sell any assets and there can be no assurancethat any such asset sales will occur or, if they occur, as to the timing oramount of proceeds that such asset sales may generate.

 

**Revolving CreditFacility.**TheCompany has a revolving credit facility (the “Revolver”) provided by HellerFinancial, Inc. (“Heller”), which matures on May 30, 2006.  Effective May 7, 2003, the Companyand Heller entered into an amendment to the Revolver which reduced thecommitted amount from $60 million to $40 million, while increasing theletter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s Senior Notes.   Fundsavailability under the Revolver is determined by a borrowing-base formula equalto a specified percentage of the value of the Company’s eligible accountsreceivable, inventory and pledged cash. At June 30, 2004, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $10.7million.  The balance remaining underthe Revolver that the Company can draw was $16.4 million at June 30, 2004($20.4 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Under an amendment effectiveSeptember 1, 2003, the interest rate margins over prime and LIBOR may beincreased by 0.25% increments when the fixed charge coverage ratio falls below(1) 2.0 to 1.0, (2) 1.75 to 1.0, (3) 1.5 to 1.0 and (4) 1.25 to 1.0 and (totalrate increase of 1.00%) or decreased by 0.25% increments when the fixed chargecoverage ratio is greater than 2.25 to 1.0 (total rate decrease of 0.25%).  At June 30, 2004, the Company’s rate onthe Revolver was 5.0%.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at June 30, 2004 of $10.8 million represents cashpledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties andcovenants, including financial covenants as to maximum capital expenditures,minimum fixed-charge coverage ratio and minimum average borrowingavailability.  At June 30, 2004,the Company was in compliance with all covenants under the Revolver.

 

**SeniorNotes**. InAugust 1998, the Company issued the public Senior Notes (the “SeniorNotes”) for the notes sold in a May 1998 Rule 144A private offering. Interestis fixed at 7.5% and is due and payable in semi-annual installments, whichbegan December 1, 1998. The Senior Notes mature on June 1, 2008.  The Senior Notes contain covenants placinglimitations on the Company’s ability to permit subsidiaries to incur certaindebts, incur certain loans, and engage in certain sale and leasebacktransactions. During the six months ended June 30, 2003, the Companyrepurchased Senior Notes with a face amount of $3.9 million. The Company wroteoff a proportionate share of deferred financing fees, resulting in a gain ofapproximately $1.1 million, which was reported as sundry (other) income in thecondensed consolidated statements of operations for the six months endedJune 30, 2003.

 

**Unsecured SponsorNote**. The Company’s Sponsor Note bears interest at10.0%, due and payable quarterly. The Sponsor Note is subordinate only uponbankruptcy or insolvency of the Company, or if upon maturity of the SeniorNotes, the Senior Notes remain unpaid. The payments began September 30, 1999. The Sponsor Note matures onJuly 22, 2009.  As provided underthe agreement, however, the Sponsor Note holder, WCAS, elected to deferquarterly interest payments of $4.0 million for each of the September 2000through September 2001 quarterly periods resulting in an increase in theprincipal amount of the Sponsor Note totaling $33.8 million.  Such election required a deferred financingfee of 30.0% of each of the interest payments being deferred.  The Company accounts for the additionalfinancing fees as a change in the effective interest rate of the debt. WCASmay, at its election, defer each future quarterly payment under similar terms.  WCAS has not elected to defer the quarterlypayments since September 2001.  Inaccordance with the terms of the Sponsor Note, on December 6, 2002, theCompany made a $90.0 million principal payment on the Sponsor Note.  A holder of Senior Notes had sought tocontest this payment.  See discussionunder Legal Proceedings.

 

**PreferredStock – Series A**.****TheCompany allocated the proceeds from its Series A preferred stock issuance basedupon the relative fair value of the preferred stock and warrants issued. Therelated discount is being accreted over a period of 8 years. For the six monthsended June 30, 2004, accretionof the related discount and accrued but unpaid dividends totaled $0.9 million,increasing the carrying amount to $17.5 million. As of June 30,2004, the stated value of the Series Apreferred stock, including accumulated but unpaid dividends, was $194.40 pershare.

 

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**PreferredStock – Series B**.****Forthe six months ended June 30, 2004, the Company accrued additional unpaid dividends for its Series B preferredstock totaling $1.4 million, increasing the carrying amount to $12.0million.  As of June 30,2004, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $336.83 pershare.

 

See Note 3 – Reclassification, contained in Notes to the CondensedConsolidated Financial Statements, for a discussion of the reclassification ofthe Series A and B Preferred Stock to the permanent equity section of theCondensed Consolidated Balance Sheets under the guidance of EITF Topic D-98,“Classification and Measurement of Redeemable Securities.”

 

**Inflation.**  Inflation has not had a material effect onthe operating results of the Company.

 

### **Contractual Obligations and Commercial Commitments.**

In the normal course of business, the Company enters into variouscontractual and other commercial commitments that impact, or could impact, theliquidity of operations. The following table outlines the commitments atJune 30, 2004:

 
|                               |   | **Total   Amounts** |   | **Less than****1 Year** |   | **1-3****Years** |   | **4-5****Years** |   | **Over 5   Years** |   |
|------------------------------------|--------|---------------------|--------|-------------------------|--------|------------------|--------|------------------|--------|--------------------|--------|
|                               |   | **(In Millions)**   |   |
| Long-term debt                     |   | $                   | 197.8  |                    | $      | —           |   | $                | — |               | $      | 94.0 |   | $ | 103.8 |   |
| Capital leases                     |   | 1.0                 |   | 0.8                     |   | 0.2              |   | —           |   | —             |   |
| Operating  leases (non-cancelable) |   | 17.2                |   | 5.4                     |   | 7.1              |   | 3.4              |   | 1.3                |   |
| Total  Contractual                 |   | 216.0               |   | 6.2                     |   | 7.3              |   | 97.4             |   | 105.1              |   |
|                               |   |                |   |                    |   |             |   |             |   |               |   |
| Unused lines  of credit            |   | $                   | 20.4   |                    | $      | 20.4             |   | $                | — |               | $      | — |   | $ | — |   |
| Standby  letters of credit         |   | 10.7                |   | 10.7                    |   | —           |   | —           |   | —             |   |
| Total  Commercial                  |   | $                   | 31.1   |                    | $      | 31.1             |   | $                | — |               | $      | — |   | $ | — |   |

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In June 2003, the Financial Accounting Standards Board (“FASB”)issued Statement of Accounting Standard (“SFAS”) No. 150, “Accounting forCertain Financial Instruments with Characteristics of Both Liabilities andEquity.” The statement is effective for financial instruments entered into or modifiedafter May 31, 2003, and otherwise is effective at the beginning of the firstinterim period beginning after June 15, 2003, except for mandatorilyredeemable financial instruments of a nonpublic entity.  For mandatorily redeemable financialinstruments of a nonpublic entity, this statement shall be effective for fiscalperiods beginning after December 15, 2003.  The Company has adopted SFAS No. 150 with no effect on theCompany’s results of operations or financial position.

 

**FACTORS AFFECTING THECOMPANY’S BUSINESS AND PROSPECTS**

 

Information provided by the Company in this Quarterly Report on Form10-Q and other documents filed with the Securities and Exchange Commissioninclude “forward-looking” information, as that term is defined in the PrivateSecurities Litigation Reform Act of 1995 (the “PSLRA”). All statements other than statements of historical fact could be deemedforward-looking statements.  TheCompany cautions investors that actual results or business conditions maydiffer materially from those projected or suggested in such forward-lookingstatements as a result of numerous factors beyond the Company’s control. TheCompany undertakes no obligation to update or revise forward-looking statementsto reflect changes in assumptions, the occurrence of unanticipated results orchanges to future operating results over time. The following is a descriptionof some of the important factors that may cause the actual results of theCompany’s operations in future periods to differ materially from those currentlyexpected or desired.

 

***General EconomicConditions***

 

The Company’s business partially depends on general economic andbusiness conditions. The Company’s sales are to businesses in a wide variety ofindustries, including banking, financial services, insurance, health care andhigh technology, and to governmental agencies. General economic conditions that cause customers to reduce or delaytheir investments in products and solutions, such as those offered by theCompany, could have a material adverse effect on the Company, including itsbusiness, operating results, financial condition and prospects.

 

Delays or reductions in technology spending could have a materialadverse effect on demand for the Company’s products and services, andconsequently on the Company.

 

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***TechnologicalChanges and Product Transitions***

 

The Company’s industry is characterized by continuing improvement intechnology, which results in the frequent introduction of new products, shortproduct life cycles and continual improvement in product price/performancecharacteristics.  The Company mustincorporate these new technologies into its products and solutions in order toremain competitive. There can be no assurance that the Company will be able tocontinue to manage technological transitions. A failure on the part of the Company to effectively manage thesetransitions of its product lines to new technologies on a timely basis couldhave a material adverse effect on the Company. In addition, the Company’s business depends on technology trends in itscustomers’ businesses.  Many of theCompany’s traditional products depend on the efficient handling of paper-basedtransactions.  To the extent thattechnological changes impact the future volume of paper transactions, theCompany’s traditional business may be adversely impacted.

 

***Dependence onSuppliers***

 

The Company’s solutions products depend on the quality of componentsthat are procured from third-party suppliers. Reliance on suppliers, as well as industry supply conditions, generallyinvolves several risks, including the possibility of defective parts (which canadversely affect the reliability and reputation of the Company’s products), ashortage of components and reduced control over delivery schedules (which canadversely affect the Company’s manufacturing efficiencies) and increases incomponent costs (which can adversely affect the Company’s profitability).

 

The Company has several single-sourced supplier relationships, eitherbecause alternative sources are not available or the relationship isadvantageous due to performance, quality, support, delivery, capacity or priceconsiderations.  If these sources areunable to provide timely and reliable supply, the Company could experience manufacturinginterruptions, delays or inefficiencies, adversely affecting its results ofoperations. Even where alternative sources of supply are available,qualification of the alternative suppliers and establishment of reliablesupplies could result in delays and a possible loss of sales, which couldaffect operating results adversely.

 

*** Indebtedness and Impact on Operating Results***

 

As a result of theCompany’s high debt to equity ratio, the Company is required to devotesignificant cash to debt service.   Thislimits the Company’s future operating flexibility and could make the Companymore vulnerable to a downturn in its operating performance or a decline ingeneral economic conditions.

 

***InternationalActivities***

 

The Company’s international operations are a significant part of theCompany’s business.  The success andprofitability of international operations are subject to numerous risks anduncertainties, such as economic and labor conditions, political instability,tax laws (including U.S. taxes on foreign subsidiaries) and changes in thevalue of the U.S. dollar versus the local currency in which products aresold.  Any unfavorable change in one ormore of these factors could have a material adverse effect on the Company.

 

***Fluctuations inOperating Results***

 

The Company’s operating results may fluctuate from period to period andwill depend on numerous factors, including the following: customer demand andmarket acceptance of the Company’s products and solutions, new productintroductions, product obsolescence, varying product mix, foreign-currencyexchange rates, competition and other factors. The Company’s business issensitive to the spending patterns of its customers, which in turn are subjectto prevailing economic conditions and other factors beyond the Company’scontrol. Any unfavorable change in one or more of these factors could have amaterial adverse effect on the Company.

 

***Product DevelopmentActivities***

 

The strength of the Company’s overall business depends in part on theCompany’s ability to develop products and solutions based on new or evolvingtechnology and the market’s acceptance of those products.  There can be no assurance that the Company’sproduct development activities will be successful, that new technologies willbe available to the Company, that the Company will be able to delivercommercial quantities of new products in a timely manner, that those productswill adhere to generally accepted industry standards or that products willachieve market acceptance.  Many of theCompany’s customers use its products in highly regulated or technologicallydemanding industries.  As a result ofproducts introduced by the Company’s competitors, generally accepted industrystandards can change rapidly in ways that are beyond the control of the Company.

 

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**ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.**

 

The Company utilizes a revolving credit facility to support workingcapital needs. The interest rate on loans under the Revolver is, at theCompany’s option, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Although no actual balances were outstandingunder the Revolver at June 30, 2004, assuming $1.0 million in borrowingsunder the Revolver, a one hundred basis point change in the bank’s prime orLIBOR rate would impact net interest expense by $10,000 over a twelve-monthperiod.

 

**ITEM4. CONTROLS AND PROCEDURES.**

 

During the audit of the Company’s 2000 financial statements, theCompany’s certifying accountant, Deloitte & Touche LLP (D&T) noted whatD&T considered to be material weaknesses in internal control design and inthe operation of internal controls.  SeeCurrent Report on Form 8-K filed with the Securities and Exchange Commission onNovember 13, 2001 for additional information regarding this item and thesubsequent change in the Company’s independent accountant.  The Company’s current independentaccountant, KPMG, LLP (KPMG), also informally noted certain internal-controlweaknesses as a result of the 2001 audit, some of which are the same weaknessesas noted by D&T in their report.

 

The Company has addressed certain of the individual internal-controlweaknesses noted by D&T and KPMG, but analysis of internal control factorscontinues on an ongoing basis.  Stepsthat have been implemented to address internal-control weaknesses includepolicies covering loss contracts, inventory reserves, allowance for doubtfulaccounts, revenue recognition, and project costing.  In addition, as a result of Exchange Act Rule 13a-14, the Companyhas put in place procedures addressing the adequacy of disclosure controls,including obtaining certifications from each member of management involved inthe preparation and review of this Form 10-Q. The Company is continuing its efforts to correct the internal-controlweaknesses noted by D&T and KPMG. Although the Company believes that it has implemented adequate controlsover financial reporting for the preparation of this report, the actions takenby the Company to correct certain of the previously identified weaknesses willnot be fully tested by the Company’s independent accountants until the annualaudit for the year ended December 31, 2005.

 

Within the 90 days prior to the filing date of this report, the ChiefExecutive Officer and the Chief Financial Officer of the Company, with theparticipation of the Company’s management, continues to evaluate theeffectiveness of the Company’s disclosure controls and procedures pursuant toExchange Act Rule 13a-14.  Basedupon the evaluation completed to date, and the new procedures put in place, theChief Executive Officer and the Chief Financial Officer believe that theCompany’s disclosure controls and procedures are effective in making known tothem material information relating to the Company (including its consolidatedsubsidiaries) required to be included in this report.  The Company will continue to evaluate disclosure controls on anongoing basis.

 

Disclosure controls and procedures, no matter how well designed andimplemented, can provide only reasonable assurance of achieving an entity’sdisclosure objectives.  The likelihoodof achieving such objectives is affected by limitations inherent in disclosurecontrols and procedures.  These includethe fact that human judgment in decision-making can be faulty and thatbreakdowns in internal control can occur because of human failures such assimple errors or mistakes or intentional circumvention of the establishedprocess.

 

There were no significant changes in the Company’s internal controls orin other factors that could significantly affect internal controls, known tothe Chief Executive Officer or the Chief Financial Officer, subsequent to thedate of the evaluation.

 

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**BANCTEC,INC.**

**PART II**

**OTHERINFORMATION**

 

**ITEM1. Legal Proceedings**

 

A lawsuit captioned Cerberus International, Ltd., et al. vs.BancTec, Inc., et al. (Case No. 03600287) was filed on January 28,2003 in the Supreme Court of the State of New York for the County of New Yorknaming as defendants the Company and certain of its affiliates.  The complaint alleged that the Companyimproperly made a payment to the holder of the Sponsor Note and sought damagesof not less than $89 million as a result of the alleged improper payment andthe imposition of a constructive trust on monies paid by the Company to theholder of the Sponsor Note.  TheCompany’s $90 million payment to the holder of the Sponsor Note was disclosedin the Company’s Current Report on Form 8-K dated November 27, 2002.

 

On May 5, 2004, the Supreme Court granted the Company’s motion forsummary judgment dismissing the plaintiff’s complaint in its entirety.  The plaintiff has filed a notice of appealof the Supreme Court’s ruling.

 

The Company is a party to various other legalproceedings.  None of those currentproceedings is expected to have an outcome that is material to the financialcondition or operations of the Company.

 

**ITEM2.  Changes in Securities and Use ofProceeds**

 

None

 

**ITEM3.  Defaults Upon Senior Securities**

 

None

 

**ITEM 4.  Submission of Matters to a Vote of SecurityHolders**

 

None

 

**ITEM5. Other Information**

 

None

 

**ITEM6. Exhibits and Reports on Form 8-K**

 

 

(a)          Exhibits:

 

31.1 – Certification of Chief ExecutiveOfficer pursuant to Rule 15d-14(a) under the Securities Exchange Act

 

31.2 – Certification of Chief FinancialOfficer pursuant to Rule 15d-14(a) under the Securities Exchange Act

 

32.1 – Certification of Chief Executive Officer pursuant to 18 USC 1350and Rule 15d-14(a) under the Sarbanes-Oxley Act

 

32.2 – Certification of Chief Financial Officer pursuant to 18 USC 1350and Rule 15d-14(a) under the Sarbanes-Oxley Act

 

(b)         Reports onForm 8-K:

 

None

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 
|   |   | **BancTec, Inc.**                                                                     |
|--------|--------|---------------------------------------------------------------------------------------|
|   |   |                                                                                  |
|   |   |                                                                                  |
|   | *By*   | */s/*                                                                                 | * Brian R. Stone* |   |
|   |   | *Brian R. Stone*                                                                      |
|   |   | *Senior Vice President on behalf of   the registrant and as Chief  Financial Officer* |
|        |        |                                                                                       |  |  |

 

Dated: August 14, 2004

 

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