**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

** **

**FORM 10-Q**

**(Mark One)**

**ý****        Quarterly Report Pursuantto Section 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the quarterly period ended March 31, 2005**

 

**OR**

 

**o****        Transition Report Pursuantto Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**Commission File 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) 821-4000**                                              |
| (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 Act of1934 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.              Yesý   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  May 12, 2005** |
|----------------------------------------|------------|----------------------------------------------------|
|                                   |       |                                               |
| 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 I**

**FINANCIAL INFORMATION**

** **

**ITEM 1.  Financial Statements**

 

**BANCTEC, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(In thousands, except share data)**

** **
| ** **                                                                                                             | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                             | ** ** | **(Unaudited)**     | ** ** | ** **             | ** ** |
| CURRENT  ASSETS:                                                                                                       |       |                |       |                   |       |
| Cash and cash  equivalents, including restricted cash of $1,801 and $4,056 at March 31, 2005  and December 31, 2004    |       | $                   | 39,667     |                   | $          | 51,487 |   |
| Accounts  receivable, less allowance for doubtful accounts of $1,040 and $931 at March  31, 2005 and December 31, 2004 |       | 51,973              |       | 45,772                 |       |
| Inventories,  net                                                                                                      |       | 23,188              |       | 24,466                 |       |
| Prepaid  expenses                                                                                                      |       | 6,413               |       | 4,950                  |       |
| Other current  assets                                                                                                  |       | 1,995               |       | 1,984                  |       |
| Total current  assets                                                                                                  |       | 123,236             |       | 128,659                |       |
|                                                                                                                   |       |                |       |                   |       |
| PROPERTY,  PLANT AND EQUIPMENT, net                                                                                    |       | 32,175              |       | 34,254                 |       |
|                                                                                                                   |       |                |       |                   |       |
| OTHER ASSETS:                                                                                                          |       |                |       |                   |       |
| Goodwill                                                                                                               |       | 41,476              |       | 41,476                 |       |
| Deferred  income tax benefit                                                                                           |       | 6,742               |       | 6,874                  |       |
| Other assets                                                                                                           |       | 4,465               |       | 4,802                  |       |
| Total other  assets                                                                                                    |       | 52,683              |       | 53,152                 |       |
|                                                                                                                   |       |                |       |                   |       |
| TOTAL ASSETS                                                                                                           |       | $                   | 208,094    |                   | $          | 216,065 |   |
|                                                                                                                   |       |                |       |                   |       |
| CURRENT  LIABILITIES:                                                                                                  |       |                |       |                   |       |
| Current  obligations under capital leases and revolver                                                                 |       | $                   | 104        |                   | $          | 299 |   |
| Trade accounts  payable                                                                                                |       | 15,171              |       | 14,479                 |       |
| Other accrued  expenses and liabilities                                                                                |       | 36,003              |       | 34,377                 |       |
| Deferred  revenue                                                                                                      |       | 22,885              |       | 23,778                 |       |
| Maintenance  contract deposits                                                                                         |       | 32,694              |       | 41,083                 |       |
| Income taxes                                                                                                           |       | 3,590               |       | 3,112                  |       |
| Total current  liabilities                                                                                             |       | 110,447             |       | 117,128                |       |
|                                                                                                                   |       |                |       |                   |       |
| OTHER  LIABILITIES:                                                                                                    |       |                |       |                   |       |
| Long-term debt                                                                                                         |       | 197,823             |       | 197,823                |       |
| Non-current  maintenance contract deposits                                                                             |       | 21,038              |       | 20,547                 |       |
| Other  noncurrent liabilities                                                                                          |       | 22,199              |       | 22,230                 |       |
| Total other  liabilities                                                                                               |       | 241,060             |       | 240,600                |       |
|                                                                                                                   |       |                |       |                   |       |
| Total  liabilities                                                                                                     |       | 351,507             |       | 357,728                |       |
| COMMITMENTS  AND CONTINGENCIES                                                                                         |       |                |       |                   |       |
|                                                                                                                   |       |                |       |                   |       |
| SERIES A  PREFERRED STOCK - issued and outstanding, 100,667 shares at March 31, 2005  and December 31, 2004            |       | 18,040              |       | 18,040                 |       |
|                                                                                                                   |       |                |       |                   |       |
| STOCKHOLDERS’  DEFICIT:                                                                                           |       |                |       |                   |       |
| Cumulative  preferred stock - authorized, 200,000 shares of $0.01 par value at March 31,  2005 and December 31, 2004   |       |                |       |                   |       |
| Series B  preferred stock - issued and outstanding, 35,520 shares at March 31, 2005 and  December 31, 2004             |       | 13,520              |       | 13,520                 |       |
| Common stock  authorized, 21,800,000 shares of $0.01 par value at March 31, 2005 and  December 31, 2004:               |       |                |       |                   |       |
| Common  stock-issued and outstanding 17,003,838 shares at March 31, 2005 and December  31, 2004                        |       | 170                 |       | 170                    |       |
| Class A common  stock-issued and outstanding 1,181,946 shares at March 31, 2005 and December  31, 2004                 |       | 12                  |       | 12                     |       |
| Subscription  stock warrants                                                                                           |       | 3,726               |       | 3,726                  |       |
| Additional  paid-in capital                                                                                            |       | 122,655             |       | 122,655                |       |
| Accumulated  deficit                                                                                                   |       | (287,691            | )          | (286,247               | )          |
| Accumulated  other comprehensive loss                                                                                  |       | (13,845             | )          | (13,539                | )          |
| Total  stockholders’ deficit                                                                                      |       | (161,453            | )          | (159,703               | )          |
|                                                                                                                   |       |                |       |                   |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                      |       | $                   | 208,094    |                   | $          | 216,065 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

2

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**BANCTEC, INC.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
| ** **                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(In thousands)**                | ** ** | **(In thousands)** | ** ** |
| REVENUE                              |       |                              |       |   |   |
| Equipment and  software              |       | $                                 | 34,411     |   | $ | 32,526 |   |
| Maintenance  and other services      |       | 54,224                            |       | 56,558 |   |
|                                 |       | 88,635                            |       | 89,084 |   |
| COST OF SALES                        |       |                              |       |   |   |
| Equipment and  software              |       | 20,225                            |       | 19,235 |   |
| Maintenance  and other services      |       | 44,199                            |       | 48,746 |   |
|                                 |       | 64,424                            |       | 67,981 |   |
| Gross profit                         |       | 24,211                            |       | 21,103 |   |
|                                 |       |                              |       |   |   |
| OPERATING  EXPENSES                  |       |                              |       |   |   |
| Product  development                 |       | 2,251                             |       | 2,485 |   |
| Selling,  general and administrative |       | 17,044                            |       | 14,651 |   |
|                                 |       | 19,295                            |       | 17,136 |   |
| Income from  operations              |       | 4,916                             |       | 3,967 |   |
|                                 |       |                              |       |   |   |
| OTHER INCOME  (EXPENSE):             |       |                              |       |   |   |
| Interest  income                     |       | 227                               |       | 138 |   |
| Interest  expense                    |       | (4,759                            | )          | (4,773 | ) |
| Sundry, net                          |       | (476                              | )          | (494 | ) |
|                                 |       | (5,008                            | )          | (5,129 | ) |
| LOSS BEFORE  INCOME TAXES            |       | (92                               | )          | (1,162 | ) |
| INCOME TAX  EXPENSE (BENEFIT)        |       | 1,352                             |       | (370 | ) |
| NET LOSS                             |       | (1,444                            | )          | (792 | ) |
|                                      |            |                                   |            |  |  |  |  |

 

See notes to unaudited condensedconsolidated financial statements.

 

3

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Three Months Ended March 31** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                        | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(In thousands)**              | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES                                              |       |                            |       |   |   |
| Net loss                                                                           |       | $                               | (1,444     | ) | $ | (792 | ) |
| Adjustments to  reconcile net loss to cash flows (used in) provided by operations: |       |                            |       |   |   |
| Depreciation  and amortization                                                     |       | 3,571                           |       | 3,974 |   |
| Provision for  doubtful accounts                                                   |       | (88                             | )          | (163 | ) |
| Deferred  income tax expense (benefit)                                             |       | 132                             |       | (1,406 | ) |
| Loss on disposition  of property, plant and equipment                              |       | 482                             |       | 131 |   |
| Other non-cash  items                                                              |       | 23                              |       | 82 |   |
| Changes in  operating assets and liabilities:                                      |       |                            |       |   |   |
| Increase in  accounts receivable                                                   |       | (6,113                          | )          | (7,962 | ) |
| Decrease  (increase) in inventories                                                |       | 926                             |       | (529 | ) |
| Increase in other  assets                                                          |       | (1,137                          | )          | (2,407 | ) |
| Increase  (decrease) in trade accounts payable                                     |       | 692                             |       | (942 | ) |
| (Decrease)  increase in deferred revenue & maintenance contracts deposits      |       | (8,791                          | )          | 11,016 |   |
| Increase  (decrease) in other accrued expenses and liabilities                     |       | 2,101                           |       | (755 | ) |
| Cash flows  (used in) provided by operating activities                             |       | (9,646                          | )          | 247 |   |
|                                                                               |       |                            |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES                                              |       |                            |       |   |   |
| Purchases of  property, plant and equipment                                        |       | (1,789                          | )          | (2,039 | ) |
| Cash flows  used in investing activities                                           |       | (1,789                          | )          | (2,039 | ) |
|                                                                               |       |                            |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES                                              |       |                            |       |   |   |
| Payments of  current maturities of capital lease obligations                       |       | (215                            | )          | (266 | ) |
| Payments on  short-term borrowing, net                                             |       | (1                              | )          | — |   |
| Cash flows  used in financing activities                                           |       | (216                            | )          | (266 | ) |
|                                                                               |       |                            |       |   |   |
| EFFECT OF EXCHANGE  RATE CHANGES ON CASH                                           |       | (169                            | )          | 403 |   |
| NET DECREASE  IN CASH AND CASH EQUIVALENTS                                         |       | (11,820                         | )          | (1,655 | ) |
| CASH AND CASH  EQUIVALENTS—BEGINNING OF PERIOD                                |       | 51,487                          |       | 61,566 |   |
|                                                                               |       |                            |       |   |   |
| CASH AND CASH  EQUIVALENTS—END OF PERIOD                                      |       | $                               | 39,667     |   | $ | 59,911 |   |
|                                                                               |       |                            |       |   |   |
| SUPPLEMENTAL  DISCLOSURES INFORMATION:                                             |       |                            |       |   |   |
| Cash paid  during the period for:                                                  |       |                            |       |   |   |
| Interest                                                                           |       | $                               | 2,737      |   | $ | 2,682 |   |
| Taxes                                                                              |       | $                               | 446        |   | $ | 1,006 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

4

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**BANCTEC, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**1.             NATUREOF 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 March 31, 2005, and the unaudited condensed consolidated statements ofoperations and cash flows for the interim periods ended March 31, 2005 and2004, should be read in conjunction with BancTec, Inc. and subsidiaries (“BancTec”or the “Company”) consolidated financial statements and notes thereto in themost recent Annual Report on Form 10-K filed with the Securities and ExchangeCommission.   In the opinion ofmanagement, the accompanying condensedconsolidated financial statements contain all material adjustments, consistingprincipally of normal recurring adjustments, necessary for a fair presentationof the financial position and results of operations of the Company. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

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

** **

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

** **

**Cash and Cash Equivalents and Short-TermInvestments**

 

Cash and cash equivalents include cash onhand and on deposit, including highly liquid investments with originalmaturities of three months or less. Short-term investments or similarinstruments with original maturities in excess of three months are valued atcost, which approximates market. Restricted cash at March 31,2005, of $1.8 million represents the cash pledged under the terms of theRevolver.

 

**Allowance for 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 costor market and include the cost of raw materials, labor, factory overhead, andpurchased subassemblies. Cost is determined using the first-in, first-out andweighted average methods.  At leastquarterly, 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 approach incorporatesboth recent historical information and management estimates of trends. TheCompany’s approach is intended to take into consideration potential excess andobsolescence caused by a decreasing installed base, engineering changes and endof manufacture.  If any of the elementsof the Company’s estimate were to deteriorate, additional write-downs may berequired. The inventory write-down calculations are reviewed periodically andadditional write-downs are recorded as deemed necessary.  Inventoryreserves as of March 31, 2005 and December 31, 2004, were $12.9 million and$13.6 million, respectively.  Inventoryreserves establish a new cost basis for inventory and are not reversed infuture periods.

 

5

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**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 two 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 three months ended March 31, 2005 and 2004 were $3.6 millionand $4.0 million respectively.

** **

**Revenue Recognition**

** **

The Company derives revenue primarily from two sources: (1) productsales - systems integration solutions which address complex data and paper-intensivework processes, including advanced web-enabled imaging and workflowtechnologies with both BancTec-manufactured equipment and third-party equipment, and (2) services - consist primarily of application design, developmentand maintenance, all aspects of desktop outsourcing, including fieldengineering, as well as help desk and LAN/WAN network outsourcing.

 

The Company applies the provisions of Statement of Position 97-2, “SoftwareRevenue Recognition,” as amended by Statement of Position 98-9 “Modificationof SOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions” to all transactions involving the sale of software products andsales of hardware where the software is not incidental. For those transactionsthat involve acceptance certificates, the Company recognizes revenue uponreceipt of the acceptance certificate, or when it can be objectivelydemonstrated 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 initial 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 invoiced. 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 one yearin duration and the revenue generated is generally recognized ratably over theterm of the contract.

 

The Company’s services revenue is primarily billed based on contractualrates and terms, and the Company generally recognizes revenue as these servicesare performed which, in some cases, is ratably over the contract term. Certain customers advance funds prior to theperformance of the services. The Company recognizes revenue related tothese advances as services are performed over time or on a “per call”basis.  The current and non-currentportions of these advances are shown as Deferred Revenue or MaintenanceContract Deposits on the Consolidated Balance Sheets.

 

**Research and Development**

 

Research and development costs are expensedas incurred.   Research and developmentcosts for the three months ended March 31, 2005, and 2004, were $2.0 millionand $2.5 million respectively.

 

6

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**Income Taxes**

 

The Company and its domestic subsidiariesfile a consolidated Federal income tax return. The Company’s foreignsubsidiaries file separate income tax returns in the countries in which theiroperations are based.

 

Income taxes are accounted for under theasset and liability method.  Deferred taxassets 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 is recognizedin income in the period that includes the enactment date.

 

**Foreign Currency Translation**

 

Foreign assets and liabilities are translatedusing the exchange rate in effect at the balance sheet date, and results ofoperations are translated using an average rate for the period. Translationadjustments are accumulated and reported as a component of stockholders’deficit and comprehensive income (loss). Transaction gains and losses areincluded in results of operations in “Sundry, net”.

 

**Stock-Based Compensation**

 

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 Company adoptedthe 2000 Stock Plan (the Plan), which provides for the grant to employees ofincentive options, non-qualified stock options, and restricted stock awards.

 

Incentive Options. During the year endedDecember 31, 2004, the Company granted 1,419,500 incentive options.  During the three months ended March 31, 2005,175,000 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 the Company. Asa 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, 2004, the Company granted 50,000 non-qualified options.  During the three months ended March 31, 2005,no non-qualified options were granted. Under the Plan, non-qualified options are granted at a fixed exerciseprice equal to, more than, or less than 100% of the fair market value of theshares of stock on the date of grant. A portion of the non-qualified optionsvest over a four-year period at 25% per year beginning January 2, 2001; theremainder vest based on the performance of the Company. As a part of anemployee retention program, vesting of 20.0% of the performance-based incentiveoptions was accelerated in October 2000.

 

7

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| ** **                                  | ** ** | **Incentive  Shares** | ** ** | **Non-qualified  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|---------------------------|------------|----------------------------------------|------------|
| Options  outstanding–December 31, 2003 |       | 482,240               |       | 31,760                    |       | 9.25                                   |       |
| Granted                                     |       | 1,419,500             |       | 50,000                    |       | 9.25                                   |       |
| Forfeited                                   |       | (126,500              | )          | (50,000                   | )          | 9.25                                   |       |
| Options  outstanding–December 31, 2004 |       | 1,775,240             |       | 31,760                    |       | 9.25                                   |       |
| Granted                                     |       | 175,000               |       | —                    |       | 9.25                                   |       |
| Forfeited                                   |       | —                |       | —                    |       | 9.25                                   |       |
| Options  outstanding–March 31, 2005    |       | 1,950,240             |       | 31,760                    |       | 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 March 31, 2005, options to purchase1,982,000 shares were outstanding, of which 316,125 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 2004 and 2005 were issued at or above marketprice, 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 consistent with SFAS No. 123:

 
| ** **                                                                                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                                                                           | ** ** | **(In thousands)**               | ** ** |
| Net loss as  reported                                                                                                |       | $                                | (1,444     | ) | $ | (792 | ) |
| Total stock-based employee compensation  expense determined under fair-value-based method for all awards, net of tax |       | (321                             | )          | (20 | ) |
| Pro Forma net  loss                                                                                                  |       | $                                | (1,765     | ) | $ | (812 | ) |

 

The fair value of each stock-option grantunder the stock option plans was estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions and results:

 
| ** **                     | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| **Weighted  Average**          | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Risk free  interest rate       |       | 4.59                             | %          | 3.96 | % |
| Expected life                  |       | 10 years                         |       | 10 years |   |
| Expected  volatility           |       | 0                                |       | 0 |   |
| Fair value of  options granted |       | $                                | 3.37       |   | $ | 2.99 |   |
|                                |            |                                  |            |  |  |  |  |

 

**3.****                                      RECLASSIFICATION**

** **

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

 

8

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**4.****                                      SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ANDFINANCING TRANSACTIONS**

** **

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

 
| ** **                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                        | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **(In thousands)**               | ** ** |
| Capital lease obligation incurred for lease  of computer hardware |       | $                                | —     |   | $ | — |   |
| Inventory put in service as fixed asset                           |       | 351                              |       | 83 |   |
|                                                                   |            |                                  |            |  |  |  |  |

 

**5.             INVENTORIES**

 

Inventory consists of the following:

 
| ** **       | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|------------------|------------|--------------------|------------|------------------|------------|
| ** **       | ** ** | **2005**           | ** ** | **2004**         | ** ** |
| ** **       | ** ** | **(In thousands)** | ** ** |
| Raw materials    |       | $                  | 6,364      |             | $          | 6,686 |   |
| Work-in-progress |       | 4,116              |       | 5,247            |       |
| Finished goods   |       | 12,708             |       | 12,533           |       |
|             |       | $                  | 23,188     |             | $          | 24,466 |   |
|                  |            |                    |            |                  |            |  |  |  |  |

 

**6.             PROPERTY,PLANT AND EQUIPMENT**

 

Property, plant and equipment consist of thefollowing:

 
| ** **                                 | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                                 | ** ** | **2005**           | ** ** | **2004**         | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| Land                                       |       | $                  | 2,860      |             | $          | 2,860 |   |
| Field support  spare parts                 |       | 37,903             |       | 38,057           |       |
| Systems and  software                      |       | 51,505             |       | 49,785           |       |
| Machinery and  equipment                   |       | 22,262             |       | 23,360           |       |
| Furniture,  fixtures and other             |       | 10,154             |       | 12,098           |       |
| Buildings                                  |       | 27,241             |       | 26,529           |       |
|                                       |       | 151,925            |       | 152,689          |       |
| Accumulated  depreciation and amortization |       | 119,750            |       | 118,435          |       |
| Property,  plant and equipment, net        |       | $                  | 32,175     |             | $          | 34,254 |   |
|                                            |            |                    |            |                  |            |  |  |  |

 

9

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**7.             OTHERACCRUED EXPENSES AND LIABILITIES**

 

Other accrued expenses and liabilitiesconsist of the following:

 
| ** **                              | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                              | ** ** | **2005**           | ** ** | **2004**         | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Salaries,  wages and other compensation |       | $                  | 13,272     |             | $          | 10,081 |   |
| Accrued taxes,  other than income taxes |       | 3,658              |       | 4,868            |       |
| Accrued  interest payable               |       | 4,963              |       | 3,204            |       |
| Accrued  invoices and costs             |       | 1,155              |       | 1,191            |       |
| Other                                   |       | 12,955             |       | 15,033           |       |
|                                    |       | $                  | 36,003     |             | $          | 34,377 |   |

 

**8.             DEBTAND OTHER OBLIGATIONS**

 

Debt and other obligations consist of thefollowing:

 
| ** **                                      | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                                      | ** ** | **2005**           | ** ** | **2004**         | ** ** |
| ** **                                      | ** ** | **(In thousands)** | ** ** |
| 7.5% Senior  Notes, due 2008                    |       | $                  | 93,975     |             | $          | 93,975 |   |
| Subordinated  Sponsor Note, unsecured, due 2009 |       | 103,848            |       | 103,848          |       |
|                                            |       | 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 will mature on May 30, 2006.  Effective May 7, 2003, the Company andHeller entered into an amendment to the Revolver which reduced the committedamount from $60 million to $40 million, while increasing the letter-of-creditsub-limit from $30 million to $40 million. The Revolver is secured by substantially all the assets of the Company,subject to the limitations on liens contained in the Company’s existing SeniorNotes.   Funds availability under theRevolver 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.  At March 31,2005, the Company had no balance outstanding under the Revolver and anoutstanding balance on letters-of-credit totaling $1.7 million.  The balance remaining under the Revolver thatthe Company can draw was $17.2 million at March 31, 2005 ($21.2 million inavailability less a $4.0 million reserve). A commitment fee of 0.5% per annum on the unused portion of the Revolveris payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 1.25% over prime or (2) 2.75% over LIBOR.  Under an amendment effective September 1,2003, the interest rate margins over prime and LIBOR may be increased by 0.25%increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0 and(2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by 0.25%increments when the fixed charge coverage ratio is greater than (1) 1.75 to1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of 0.75%).  The interest rate was remeasured as of theeffective date of September 1, 2003 under this amendment.  At March 31, 2005, the Company’s weightedaverage rate on the Revolver was 7.5% under the prime option.

 

10

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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 March 31, 2005 of $1.8 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.  Effective December 31,2004, the Company and Heller amended the loan and security agreement todecrease the minimum fixed charge coverage ratio at December 31, 2004 to 1.1 to1.0.  Effective March 31, 2005, the loanand security agreement was further amended to add a triggering event for thefixed charged coverage ratio covenant. No fixed charge coverage ratio covenant applies when cash balancesexceed $20 million and the outstanding balance on the revolver is less than$250,000.  If either of these conditionsis not met, then the fixed charge covenant ratio requirement becomes 1.1 to1.0.  At March 31, 2005, the Company wasin 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 Notes containcovenants placing limitations on the Company’s ability to permit subsidiariesto incur certain debts, incur certain loans, and engage in certain sale andleaseback transactions.  The estimated fair value of the SeniorNotes as of March 31, 2005, is approximately $66.9 million based on an averagevalue of the most recently completed market trades, resulting in ayield-to-maturity of approximately 20%. The number of actual trades is limited; therefore the result may vary ifa widely traded market environment existed.

 

Subordinated Unsecured Sponsor Note. TheCompany’s Sponsor Note bears interest at 10.0%, due and payable quarterly. TheSponsor Note is subordinate only upon bankruptcy or insolvency of the Company,or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. Asprovided under the agreement, however, the Sponsor Note holder, Welsh, Carson,Anderson & Stowe (“WCAS’), elected to defer quarterly interest payments of$4.0 million for each of the September 2000 through September 2001 quarterlyperiods resulting in an increase in the principal amount of the Sponsor Notetotaling $33.8 million.  Such electionrequired a deferred financing-fee of 30.0% of each of the interest paymentsbeing deferred.  The Company accounts forthe additional financing fees as a change in the effective interest rate of thedebt. WCAS may, at its election, defer each future quarterly payment undersimilar terms.  WCAS has not elected todefer the quarterly payments since September 2001.  In accordance with the terms of the SponsorNote, on December 6, 2002, the Company made a $90.0 million principal paymenton the Sponsor Note.  The estimatedfair-value of the Sponsor Note and deferred interest and fees as of March 31,2005, is approximately $63.3 million assuming a yield-to-maturity of 25%.

 

The Company had no outstanding balances onforeign credit agreements at March 31, 2005.

 

Capital Leases.  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 currentobligations under capital leases are classified in the current liabilitiessection of the Condensed Consolidated Balance Sheets and the non-currentportion of capital leases are included in Other Liabilities.  At March 31, 2005, the Company had capitallease balances outstanding of $0.3 million, of which $0.1 million wasclassified as current and $0.2 million was classified as long-term.

 

**9.             GOODWILL ANDINTANGIBLE ASSETS**

 

Beginning January 1, 2002, the Companyadopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwilland Other Intangible Assets”.  SFAS No.142 requires that goodwill and intangible assets with indefinite useful livesno longer be amortized but instead be tested for impairment at leastannually.  SFAS No. 142 also requiresthat intangible assets with definite useful lives be amortized over theirrespective estimated useful lives to their estimated 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,

 

11

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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.

 

Components of the Company’s goodwill include amounts that are foreigncurrency denominated.  These goodwillamounts are subject to translation at each balance sheet date.  The Company records the change to itsAccumulated Other Comprehensive Loss on the balance sheet.  Goodwill previously classified as unallocatedhas been allocated to the reporting units as required by SFAS No. 142.  There were no changes in the carrying amount of goodwill by segment for the threemonths ended March 31, 2005 or March31, 2004.

** **

**10.          PENSION BENEFITS**

** **

Net periodic pension costs included the following components for thethree months ended March 31:

** **
| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In thousands)**               | ** ** |
| Components of  net period benefits cost: |       |                             |       |   |   |
| Service cost                             |       | $                                | 98         |   | $ | 112 |   |
| Interest cost                            |       | 349                              |       | 397 |   |
| Expected  return on plan assets          |       | (241                             | )          | (274 | ) |
| Recognized  actuarial loss               |       | 95                               |       | 108 |   |
| Net periodic  benefit cost               |       | $                                | 301        |   | $ | 343 |   |

 

12

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**11.          TAXES**

 

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

 
| ** **                             | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                             | ** ** | **2005**           | ** ** | **2004**         | ** ** |
| ** **                             | ** ** | **(In thousands)** | ** ** |
| Gross deferred  tax assets:            |       |               |       |             |       |
| Net operating  losses                  |       | $                  | 51,237     |             | $          | 47,335 |   |
| AMT credit  carryforwards              |       | 101                |       | 101              |       |
| Inventory  reserves                    |       | 4,751              |       | 4,948            |       |
| Receivable  allowance                  |       | 194                |       | 205              |       |
| Intangible  assets previously deducted |       | 796                |       | 905              |       |
| Deferred  revenues                     |       | 12,902             |       | 15,450           |       |
| Deferred  compensation                 |       | 3,154              |       | 2,639            |       |
| Foreign timing  differences, net       |       | 9,088              |       | 9,088            |       |
| Other                                  |       | 5,833              |       | 5,723            |       |
| Total gross  deferred tax asset        |       | 88,056             |       | 86,394           |       |
| Gross deferred  tax liabilities:       |       |               |       |             |       |
| Depreciation                           |       | (1,449             | )          | (1,352           | )          |
| Total gross  deferred tax liability    |       | (1,449             | )          | (1,352           | )          |
| Deferred tax  asset valuation reserve  |       | (77,881            | )          | (76,184          | )          |
| Net deferred  tax asset                |       | $                  | 8,726      |             | $          | 8,858 |   |

 

A valuation allowance has been provided toreduce the deferred tax assets to an amount management believes is more likelythan not to be realized. Expected realization of deferred tax assets for whicha valuation allowance has not been recognized is based upon the reversal ofexisting taxable temporary differences and taxable income expected to begenerated in the future.

 

Components of the valuation allowance are as follows:

 
| ** **                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(In  thousands)**              | ** ** |
| Valuation allowance at beginning of year  |       | $                                | 76,184     |   | $ | 63,874 |   |
| (Release) Increase in valuation allowance |       | (118                             | )          | (258 | ) |
| Income from continuing operations         |       | 1,815                            |       | 69 |   |
| Prior year true-ups and corrections       |       | —                           |       | — |   |
| Valuation allowance at end of period      |       | $                                | 77,881     |   | $ | 63,685 |   |

 

Undistributed earnings of foreignsubsidiaries included in continuing operations were approximately $ 19.6million and $17.7 million at March 31, 2005 and December 31, 2004,respectively.  No taxes have beenprovided on the undistributed earnings as they are considered to be permanentlyreinvested.

 

13

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**12.          WARRANTYLIABILITY**

 

TheCompany offers various product warranties for hardware sold to itscustomers.  The specific terms and conditions of the warranties varydepending upon the customer and the product sold.  Factors that affect theCompany’s warranty liability include number of products sold, historical andanticipated rates of warranty claims and cost per claim.  The Companyaccrues for estimated warranty costs as sales are made and periodicallyassesses the adequacy of its recorded warranty liability and adjusts the amountas necessary.

 

Changesto the Company’s warranty liability, which is reported as a component of otheraccrued expenses and liabilities in the accompanying condensed consolidatedbalance sheet during the three months ended March 31, 2005 are summarized asfollows:

 
| ** **                                        | ** ** | **(In thousands)** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|
| Balance at December 31, 2004                      |       | $                  | 180        |   |
| Warranties issued                                 |       | 120                |       |
| Claims paid/settlements                           |       | (61                | )          |
| Changes in liability for pre-existing  warranties |       | —             |       |
| Balance at March 31, 2005                         |       | $                  | 239        |   |

** **

**13.          COMPREHENSIVE LOSS**

 

The components of comprehensive loss were as follows:

 
| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In thousands)**               | ** ** |
| Net loss                                 |       | $                                | (1,444     | ) | $ | (792 | ) |
| Foreign currency translation adjustments |       | (306                             | )          | 463 |   |
| Total comprehensive loss                 |       | $                                | (1,750     | ) | $ | (329 | ) |
|                                          |            |                                  |            |  |  |  |  |  |  |

 

**14.          BUSINESSSEGMENT DATA**

 

The Company segments its operations based ongeographical areas (North American Operations (“NAOPS”) and European Operations (“EUOPS”)) and productlines (Computer and Network Services (“CNS”). EUOPS offers similar products asNAOPS and consists primarily of operations throughout the world excluding theUnited States and Canada.  The Companyrecently realigned its reporting structure and began reporting under the newalignment in the first quarter of 2005. Under this new structure.  NAOPSincludes the operations of the Company’s Canadian operations and the operationsof Plexus® products (“Plexus”)that were previously reported in International Solutions.  The operations of Plexus and Canada are notmaterial to EUOPS or to NAOPS.  Under thenew structure the composition of CNS remains unchanged.  Prior period information has beenreclassified to reflect the new alignment.

 

14

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| ** **                                 | ** ** | **North  American  Operations** | ** ** | **Computer &  Network  Services** | ** ** | **European  Operations** | ** ** | **Corp/Elims** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|--------------------------|------------|----------------|------------|-----------|------------|
| ** **                                 | ** ** | **(In thousands)**              | ** ** |
| For the three  months ended March 31, 2005 |       |                            |       |                                  |       |                     |       |           |       |      |       |
|                                       |       |                            |       |                                  |       |                     |       |           |       |      |       |
| Revenue from  external customers           |       | $                               | 29,927     |                                  | $          | 31,156                   |       | $              | 27,552     |      | $          | — |   | $ | 88,635 |   |
| Intersegment  revenue                      |       | 1,484                           |       | —                                |       | 1,862                    |       | (3,346         | )          | —    |       |
| Segment gross  profits                     |       | 10,401                          |       | 3,577                                 |       | 10,244                   |       | (11            | )          | 24,211    |       |
| Segment  operating income (loss)           |       | 4,826                           |       | 2,063                                 |       | 3,651                    |       | (5,624         | )          | 4,916     |       |
| Segment  identifiable assets               |       | 85,812                          |       | 23,993                                |       | 50,279                   |       | 48,010         |       | 208,094   |       |
| Capital  appropriations                    |       | 427                             |       | 332                                   |       | 546                      |       | 836            |       | 2,141     |       |
|                                       |       |                            |       |                                  |       |                     |       |           |       |      |       |
| For the three  months ended March 31, 2004 |       |                            |       |                                  |       |                     |       |           |       |      |       |
|                                       |       |                            |       |                                  |       |                     |       |           |       |      |       |
| Revenue from  external customers           |       | $                               | 32,587     |                                  | $          | 31,616                   |       | $              | 24,881     |      | $          | — |   | $ | 89,084 |   |
| Intersegment  revenue                      |       | 1,607                           |       | —                                |       | 1,247                    |       | (2,854         | )          | —    |       |
| Segment gross  profits                     |       | 10,350                          |       | 2,382                                 |       | 8,791                    |       | (420           | )          | 21,103    |       |
| Segment  operating income (loss)           |       | 3,830                           |       | (41                                   | )          | 2,982                    |       | (2,804         | )          | 3,967     |       |
| Segment  identifiable assets               |       | 80,961                          |       | 26,575                                |       | 56,699                   |       | 84,004         |       | 248,239   |       |
| Capital  appropriations                    |       | 850                             |       | 696                                   |       | 562                      |       | 36             |       | 2,144     |       |
|                                            |            |                                 |            |                                       |            |                          |            |                |            |           |            |  |  |  |  |  |  |  |  |  |

 

**15.          PREFERREDSTOCK**

 

**SERIES A PREFERRED STOCK**

 

The Company allocated the proceeds from itsSeries A preferred stock issuance based upon the relative fair value of thepreferred stock and warrants issued.  Therelated discount was being accreted over a period of 8 years through March 31,2004, when the mandatory redemption provision was removed from the Series APreferred Stock.  Effective January 1,2005, the Series A Preferred Stock agreement was amended to eliminate thedividends payable on the Series A Preferred Stock.  As a result, no dividends were accrued duringthe three months ended March 31, 2005. As of March 31, 2005,the stated value of the Series A preferred stock, including accumulated butunpaid dividends, was $201.32 per share.

 

**SERIES B PREFERRED STOCK**

** **

Effective January 1, 2005, the Series BPreferred Stock agreement was amended to eliminate the dividends payable on theSeries B Preferred Stock.  As a result,no dividends were accrued during the three months ended March 31, 2005.  As of March 31, 2005, the stated value of the Series B preferredstock, including accumulated but unpaid dividends, was $380.63 per share.

 

**16.          RECENTACCOUNTING PRONOUNCEMENTS**

 

On December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment*.*” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for(a) equity instruments of the enterprise or (b) liabilities that arebased on the fair value of the enterprise’s equity instruments or that may besettled by the issuance of such equity instruments. SFAS No. 123Reliminates the ability to account for share-based compensation transactionsusing Accounting Principles Board Opinion No. 25 and generally requiresthat such transactions be accounted for using a fair-value-based method.  The Company is required to adopt SFAS No.123(R) in fiscal 2006, beginning January 1, 2006.  The Company is currently assessing the finalimpact of this standard on the company’s consolidated results of operations,financial position, and cash flows. This assessment includes evaluating optionvaluation methodologies and assumptions as well as potential changes to theCompany’s compensation strategies.

 

15

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In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,”**which will become effective forthe Company beginning January 1, 2006. This standard clarifies that abnormalamounts of idle facility expense, freight, handling costs and wasted materialshould be expensed as incurred and not included in overhead. In addition, thisstandard requires that the allocation of fixed production overhead costs toinventory be based on the normal capacity of the production facilities. TheCompany is currently evaluating the potential impact of this standard on itsfinancial position and results of operations, but does not believe the impactof the change will be material.

 

On October 22, 2004, a new tax law was passed, the American JobsCreation Act of 2004 (the “Jobs Creation Act”), which raised a number of issueswith respect to accounting for income taxes. In response, on December 21, 2004,the FASB issued two FASB Staff Positions (FSP), FSP 109-1—”Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004” and FSP 109-2—”Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004,”**which became effective for theCompany upon issuance.

 

The Jobs Creation Act provides a deduction for income from qualifieddomestic production activities, to be phased in from 2005 through 2010, whichis intended to replace the existing extra-territorial income exclusion forforeign sales. In FSP 109-1, the FASB decided the deduction for qualifieddomestic production activities should be accounted for as a special deductionunder SFAS No. 109, rather than as a rate reduction. Accordingly, any benefitfrom the deduction will be reported in the period in which the deduction isclaimed on the tax return and no adjustment to deferred taxes at December 31,2004, is required.

 

The Jobs Creation Act also creates a temporary incentive for U.S.corporations to repatriate accumulated income earned abroad by providing an 85percent dividends received deduction for certain dividends from controlledforeign corporations. The deduction is subject to a number of limitations anduncertainty remains as to how to interpret numerous provisions in the Act. FSP109-2 addresses when to reflect in the financial statements the effects of theone-time tax benefit on the repatriation of foreign earnings. Under SFAS No.109, companies are normally required to reflect the effect of new tax lawchanges in the period of enactment. FSP 109-2 provides companies additionaltime to determine the amount of earnings, if any, that they intend torepatriate under the Jobs Creation Act’s provisions.  As of March 31, 2005, the Company was not ina position to decide on whether, and to what extent, foreign earnings that havenot yet been remitted to the U.S. may be repatriated.

 

**17.          SUBSEQUENTEVENTS**

 

None

 

16

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND**

**RESULTS OF 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 the PrivateSecurities Litigation Reform Act of 1995 (the “PSLRA”) that involve risks anduncertainties, as well as assumptions that, if they never materialize or proveincorrect, could cause the results of BancTec, Inc. and its consolidatedsubsidiaries (the “Company”) to differ materially from those expressed orimplied by such forward-looking statements. All statements other thanstatements of historical fact are statements that could be deemedforward-looking statements, including any projections of earnings, revenues, orother financial items; any statements of the plans, strategies, and objectivesof management for future operations; any statements concerning proposed newproducts, services, or developments; any statements regarding future economicconditions or performance; statements of belief and any statement ofassumptions underlying any of the foregoing. The risks, uncertainties and assumptionsreferred to above include 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,including inventory; the flow of products into third-party distributionchannels; the difficulty of keeping expense growth at modest levels whileincreasing revenues; and other risks that are described from time to time inthe Company’s Securities and Exchange Commission reports, including but notlimited to the items discussed in “Factors Affecting the Company’s Business andProspects” set forth in this report, and items described in the Company’s otherfilings with the Securities and Exchange Commission. The Company undertakes noobligation to update or revise forward-looking statements to reflect changes inassumptions, the occurrence of unanticipated results or changes to futureoperating results over time.*

 

**Overview**

 

The Company believes several factors continued to create a challengingand competitive sales and cost-containment environment during the three monthsended March 31, 2005.  These factorsinclude: general economic conditions and reduced corporate customer technologyspending; ongoing competitive pressures; an ongoing planned change in revenuemix within the Company’s North American Operations (“NAOPS”) and EuropeanOperations (“EUOPS”) 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 three months ended March 31, 2005, the NAOPSand EUOPS segments experienced revenue declines in the maintenance business,the duration of which the Company cannot predict.

 

Expected economic and business conditions into the remainder of 2005indicate a cautious outlook regarding the Company’s near-term revenue andearnings growth prospects.  Most of theCompany’s product offerings represent a significant capital expenditure for itscustomers.  General economic conditionsand the impact of check truncation have caused a continued weakening in demandfor payment and check solutions products offered in North America. The Companycontinues to introduce new product offerings in its Enterprise ContentManagement (“ECM”) solutions as well as expand its managed services businessinto North America.  In addition, theCompany continues to seek reductions in operating costs.  Product-development efforts are focused onECM solutions as well as hardware enhancements. By incorporating morethird-party products into the Company’s solutions rather than developing theproducts, the Company can more easily target its efforts and expenditures tothese core products and solutions.

 

17

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**RESULTS OF OPERATIONS**

 

**Comparison of Three Months Ended March 31,2005 and Three Months Ended March 31, 2004**

 

Consolidated revenue of $88.6 million for thethree months ended March 31, 2005 decreased by $0.5 million or 0.6% from thecomparable prior-year period.  The NorthAmerican Operations (“NAOPS”) revenue decrease of $2.7 million was partiallyrelated to a decline in maintenance revenue due to the Company’s installedproducts reaching the end of their useful lives and from increasedcompetition.  The Company expects thesetrends to continue on these end-of-life products.  In addition, a decline in revenues related tothe sale and installation of hardware and software products was primarily relatedto a weak market for payments solutions due to market trends, including reducedcheck volume, check truncation, and the recent passage of Check 21.  Increases in European Operations (“EUOPS”) of$2.7 million are the result of the impact of the weakening dollar on theconversion of revenue stated in foreign currencies and the continued growth inthe United Kingdom of managed services as well as increased sales in Europe ofECM solutions.  A decrease in Computer &Network Services (“CNS”) of $0.4 million resulted from pricing decreases,domestic competitive pressure, and decreased volume under certain maintenanceprograms, partially offset by revenue increases from the expansion by CNS ofoperations in Europe.  Factors expectedto impact future revenue include corporate-customer spending for largesystems-solutions, the continued impacts of check truncation, on-goingcompetitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $24.2 millionincreased by $3.1 million or 14.7% from the comparable prior-year period.  Gross profit remained flat for NAOPS,increased by $1.2 million or 50.0% for CNS and increased by $1.4 million or15.9% for EUOPS.  Although revenuedecreased in NAOPS, the impact to gross profit was offset by an increase in theNAOPS gross profit percentage as a result of ongoing cost-containment effortsaimed at improving efficiency in the maintenance organization. The NAOPS grossmargin percentage increased from 31.8% to 34.8%.  Increases in EUOPS gross profit resultedpartially from increased revenue and including the impact of currencyconversion.  Continued efforts to provideproven deliverables as well as targeted new offerings, including EDMsolutions, archive solutions and hardware enhancements, which, along with ongoing cost-containment efforts, allowed forcost reductions to strengthen the EUOPS gross profit.  CNS’ gross profit percentageincreased from 7.6% to 11.5%, due to cost-containment efforts and the expansionby CNS of operations in Europe. CNS is the major component in the maintenance and other servicescategory on the Consolidated Statements of Operations, and therefore is asignificant contributing factor in the increased gross profit in themaintenance and other services category.

 

Operating expenses of $19.3 million increased$2.2 million compared to the prior-year period. Product-development expenses decreased by $0.2 million or 8.0% primarilydue to the timing of research projects. In the first quarter of 2004, development was being completed on theCompany’s new high speed scanner introduced in 2004.  Selling, general and administrative expenses(“SG&A”) increased by $2.3 million or 15.6% primarily due toincreased marketing activities related to an expansion and refocus of thecorporate marketing strategy, increased sales expense resulting from anexpansion of the sales force to support new product strategies, and increaseddepreciation expense.

 

Interest expense for the threemonths ended March 31, 2005 of $4.8 million was unchanged from the comparableprior-year period.

 

Sundry items resulted in a net loss for the three months ended March31, 2005, of $0.5 million, which was unchanged from the comparable prior-yearperiod.  Foreign exchange losses are theprimary cause of the net loss for both the three months ended March 31, 2005and the comparable prior year period.

 

An income tax provision of $1.4 million for the three months endedMarch 31, 2005 compared to acorresponding prior-year period income tax benefit of $0.4 million.  The income tax provision for the current-yearperiod related primarily to income from the Company’s internationalsubsidiaries.    The Company’s effectivetax rate was approximately (1,469.6%) for the three months ended March 31, 2005 as compared to 31.8% for thecorresponding prior-year period.

 

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**LIQUIDITY AND 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 will mature May 30, 2006, and byinternally generated funds from cash flows from operations. Funds availabilityunder the revolving credit agreement is determined by a borrowing-base formulaequal to a specified percentage of the value of the Company’s eligible accountsreceivable, inventory and pledged cash. General economic conditions, the current weakness in demand for theCompany’s systems solutions products and the requirement to obtain performancebonds or similar instruments could have an impact on the Company’s futureliquidity.

 

The Company’s cash and cash equivalentstotaled $39.7 million at March 31, 2005, compared with $51.5 million at December 31, 2004. Working capitalincreased $1.2 million during the three months ended March 31, 2005 to working capital of $12.8 million compared toworking capital of $11.5 million at December 31, 2004.  The change in working capital included acurrent liability decease of $6.7 million resulting from $9.3 million decreasein deferred revenue and maintenance contract deposits, an increase inaccrued liabilities of $1.6 million, an accountsreceivable increase of $6.2 million, an inventory decrease of $1.2 million anda prepaid expense increase of $1.5 million.

 

During the three months ended March31, 2005, the Company relied primarily oncash reserves to fund operations. At March 31, 2005, the Company had available $21.2 million ofborrowing capacity under the Revolver, of which the Company can draw$17.2 million.

 

Operating activities used $9.6 million ofcash and provided $0.2 million of cash in the three months ended March31, 2005 and 2004, respectively, a decreaseof $9.8 million.  The net loss increased$0.6 million from the prior-year period. In addition, cash generated by changes in working capital assets andliabilities was $10.7 million less than in the prior-year period.

 

Investing activities used net cash of $1.8million and $2.0 million in the three months ended March 31, 2005 and 2004, respectively. Both uses of cashrelated to purchases of property, plant and equipment.

 

Financing activities used $0.2 million foreach of the three months ended March 31, 2005 and 2004, respectively.  Both uses of cash related primarily to thereduction of the Company’s debt.

 

At March 31, 2005, the Company’s principal outstanding debt instrumentsconsisted of (i) no balance outstanding under the revolving credit facilitymaturing May 30, 2006 (which is more fully described below), (ii)  $94.0 million of 7.5% Senior Notes due 2008,and (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 incompliance with the covenants 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 from timeto 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 agreements oragreements in principle to sell any assets and there can be no assurance thatany such asset sales will occur or, if they occur, as to the timing or amountof proceeds that such asset sales may generate.

 

**Revolving Credit Facility.**The Company has a revolving credit facility (the “Revolver”)provided by Heller Financial, Inc. (“Heller”), which will mature on May 30,2006.  Effective May 7, 2003, theCompany and 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 March 31, 2005, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $1.7million.  The balance remaining under theRevolver that the Company can draw was $17.2

 

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million at March 31, 2005 ($21.2 million in availability less a $4.0million reserve).  A commitment fee of0.5% per annum on the unused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 1.25% over prime or (2) 2.75% over LIBOR.  Under an amendment effective September 1,2003, the interest rate margins over prime and LIBOR may be increased by 0.25%increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0 and(2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by 0.25%increments when the fixed charge coverage ratio is greater than (1) 1.75 to1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of 0.75%).  The interest rate was remeasured as of theeffective date of September 1, 2003 under this amendment.  At March 31, 2005, the Company’s weightedaverage rate on the Revolver was 7.5% under the prime option.

 

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 March 31, 2005 of $1.8 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.  Effective December 31,2004, the Company and Heller amended the loan and security agreement to decreasethe minimum fixed charge coverage ratio at December 31, 2004 to 1.1 to1.0.  Effective March 31, 2005, the loanand security agreement was further amended to add a triggering event for thefixed charged coverage ratio covenant. No fixed charge coverage ratio covenant applies when cash balancesexceed $20 million and the outstanding balance on the revolver is less than$250,000.  If either of these conditionsis not met, then the fixed charge covenant ratio requirement becomes 1.1 to1.0.  At March 31, 2005, the Company wasin compliance with all covenants under the Revolver.

 

**Senior Notes**. In August 1998, the Company exchanged thepublic Senior Notes (the “Senior Notes”) for the notes sold in a May 1998 Rule144A private offering. Interest is fixed at 7.5% and is due and payable insemi-annual installments, which began December 1, 1998. The Senior Notes matureon June 1, 2008.  The Senior 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.

 

**Subordinated Unsecured Sponsor Note**. TheCompany’s Sponsor Note bears interest at 10.0%, due and payable quarterly. TheSponsor Note is subordinate only upon bankruptcy or insolvency of the Company,or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. TheSponsor Note matures on July 22, 2009. As provided under the agreement, however, the Sponsor Note holder, WCAS,elected to defer quarterly interest payments of $4.0 million for each of theSeptember 2000 through September 2001 quarterly periods resulting in anincrease in the principal amount of the Sponsor Note totaling $33.8million.  Such election required adeferred financing-fee of 30.0% of each of the interest payments beingdeferred.  The Company accounts for theadditional financing fees as a change in the effective interest rate of thedebt. WCAS may, at its election, defer each future quarterly payment under similarterms.  WCAS has not elected to defer thequarterly 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.

 

**Preferred Stock – Series A**.****The Companyallocated the proceeds from its Series A preferred stock issuance based uponthe relative fair value of the preferred stock and warrants issued.  The related discount was being accreted overa period of 8 years through March 31, 2004, when the mandatory redemptionprovision was removed from the Series A Preferred Stock.  Effective January 1, 2005, the Series APreferred Stock agreement was amended to eliminate the dividends payable on theSeries A Preferred Stock.  As a result,no dividends were accrued during the three months ended March 31, 2005.  As of March 31, 2005, the stated value of the Series A preferredstock, including accumulated but unpaid dividends, was $201.32 per share.

 

**Preferred Stock – Series B**.****EffectiveJanuary 1, 2005, the Series B Preferred Stock agreement was amended toeliminate the dividends payable on the Series B Preferred Stock.  As a result, no dividends were accrued duringthe

 

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three months ended March 31, 2005.  As of March 31, 2005, the stated value of the Series B preferredstock, including accumulated but unpaid dividends, was $380.63 per share.

 

**Inflation.** Inflation has not had a material effect on the operating results of theCompany.

 

### **ContractualObligations 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 at March31, 2005:

 
| ** **                         | ** ** | **Total  Amounts** | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **Over 5  Years** | ** ** |
|------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|-------------------|------------|
| ** **                         | ** ** | **(In Millions)**  | ** ** |
| Long-term debt                     |       | $                  | 197.8      |                  | $          | —         |       | $              | —     |              | $          | 197.8 |   | $ | — |   |
| Capital leases                     |       | 0.3                |       | 0.1                   |       | 0.2            |       | —         |       | —            |       |
| Purchase  Obligations              |       | 2.0                |       | 0.7                   |       | 1.3            |       | —         |       | —            |       |
| Operating  leases (non-cancelable) |       | 14.5               |       | 5.3                   |       | 6.1            |       | 2.1            |       | 1.0               |       |
| Total  Contractual                 |       | 214.6              |       | 6.1                   |       | 7.6            |       | 199.9          |       | 1.0               |       |
|                               |       |               |       |                  |       |           |       |           |       |              |       |
| Unused lines  of credit            |       | $                  | 16.8       |                  | $          | 16.8           |       | $              | —     |              | $          | — |   | $ | — |   |
| Standby  letters of credit         |       | 1.7                |       | 1.7                   |       | —         |       | —         |       | —            |       |
| Total  Commercial                  |       | $                  | 18.5       |                  | $          | 18.5           |       | $              | —     |              | $          | — |   | $ | — |   |

 

*Purchase Obligations* – Purchase obligations are defined ascontractual obligations to purchase goods or services that are enforceable andlegally binding on the Company and that specify all significant terms,including fixed or minimum quantities to be purchased: fixed, minimum, orvariable price provisions: and the approximate timing of the transaction.  Purchase obligations do not include contractsthat may be cancelled without penalty.

** **

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

On December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment*.*” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for(a) equity instruments of the enterprise or (b) liabilities that arebased on the fair value of the enterprise’s equity instruments or that may besettled by the issuance of such equity instruments. SFAS No. 123Reliminates the ability to account for share-based compensation transactionsusing Accounting Principles Board Opinion No. 25 and generally requiresthat such transactions be accounted for using a fair-value-based method.  The Company is required to adopt SFAS No.123(R) in fiscal 2006, beginning January 1, 2006.  The Company is currently assessing the finalimpact of this standard on the company’s consolidated results of operations,financial position, and cash flows. This assessment includes evaluating optionvaluation methodologies and assumptions as well as potential changes to theCompany’s compensation strategies.

 

In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,”**which will become effective forthe Company beginning January 1, 2006. This standard clarifies that abnormalamounts of idle facility expense, freight, handling costs and wasted materialshould be expensed as incurred and not included in overhead. In addition, thisstandard requires that the allocation of fixed production overhead costs toinventory be based on the normal capacity of the production facilities. TheCompany is currently evaluating the potential impact of this standard on itsfinancial position and results of operations, but does not believe the impactof the change will be material.

 

On October 22, 2004, a new tax law was passed, the American JobsCreation Act of 2004 (the “Jobs Creation Act”), which raised a number of issueswith respect to accounting for income taxes. In response, on December 21, 2004,the FASB issued two FASB Staff Positions (FSP), FSP 109-1—”Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American

 

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Jobs Creation Act of 2004” andFSP 109-2—”Accounting and DisclosureGuidance for the Foreign Earnings Repatriation Provision within the AmericanJobs Creation Act of 2004,”**whichbecame effective for the Company upon issuance.

 

The Jobs Creation Act provides a deduction for income from qualifieddomestic production activities, to be phased in from 2005 through 2010, whichis intended to replace the existing extra-territorial income exclusion forforeign sales. In FSP 109-1, the FASB decided the deduction for qualifieddomestic production activities should be accounted for as a special deductionunder SFAS No. 109, rather than as a rate reduction. Accordingly, any benefitfrom the deduction will be reported in the period in which the deduction isclaimed on the tax return and no adjustment to deferred taxes at December 31,2004, is required.

 

The Jobs Creation Act also creates a temporary incentive for U.S.corporations to repatriate accumulated income earned abroad by providing an 85percent dividends received deduction for certain dividends from controlledforeign corporations. The deduction is subject to a number of limitations anduncertainty remains as to how to interpret numerous provisions in the Act. FSP109-2 addresses when to reflect in the financial statements the effects of theone-time tax benefit on the repatriation of foreign earnings. Under SFAS No.109, companies are normally required to reflect the effect of new tax lawchanges in the period of enactment. FSP 109-2 provides companies additionaltime to determine the amount of earnings, if any, that they intend to repatriateunder the Jobs Creation Act’s provisions. As of March 31, 2005, the Company was not in a position to decide onwhether, and to what extent, foreign earnings that have not yet been remittedto the U.S. may be repatriated.

** **

**FACTORS AFFECTING THE COMPANY’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 are statementsthat could be deemed forward-looking statements.  The Company cautions investors that there canbe no assurance that actual results or business conditions will not differmaterially from those projected or suggested in such forward-looking statementsas a result of numerous factors beyond the Company’s control. The Companyundertakes no obligation to update or revise forward-looking statements toreflect 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 thosecurrently expected or desired.

 

***General Economic Conditions***

 

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.

 

***Technological Changes 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.

 

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***Dependence on Suppliers***

 

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 experiencemanufacturing interruptions, delays or inefficiencies, adversely affecting itsresults of operations. 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 the Company’s high debt to equity ratio, the Company isrequired to devote significant cash to debt service.   This limits the Company’s future operatingflexibility and could make the Company more vulnerable to a downturn in itsoperating performance or a decline in general economic conditions.

 

***International Activities***

 

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 in Operating Results***

 

The Company’s operating results may fluctuate from period to period andwill depend on numerous factors, including: customer demand and marketacceptance of the Company’s products and solutions, new product introductions,product obsolescence, varying product mix, foreign-currency exchange rates,competition and other factors. The Company’s business is sensitive to thespending patterns of its customers, which in turn are subject to prevailingeconomic conditions and other factors beyond the Company’s control. Anyunfavorable change in one or more of these factors could have a materialadverse effect on the Company.

 

***Product Development Activities***

 

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 theCompany.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURE ABOUT MARKET RISK.**

 

The Company utilizes a revolving creditfacility to support working capital needs. The interest rate onloans under the Revolver is, at the Company’s option, either (1) 1.25% overprime or (2) 2.75% over LIBOR.  Although no

 

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actual balances were outstanding under theRevolver at March 31, 2005, assuming $1.0 million in borrowings under the Revolver,a one hundred basis point change in the bank’s prime or LIBOR rate would impactnet interest expense by $10,000 over a twelve-month period.

 

**ITEM 4. 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 independent accountant,KPMG, LLP (KPMG), also informally noted certain internal-control weaknesses asa result of the 2001 audit, some of which are the same weaknesses as noted byD&T in their report.

 

The Company has addressed the individual internal-control weaknessesnoted by D&T and KPMG, and analysis of internal control factors continueson an ongoing basis.  Steps that havebeen implemented to address internal-control weaknesses include policiescovering loss contracts, inventory reserves, allowance for doubtful accounts,revenue recognition, and project costing. In addition, as a result of Exchange Act Rule 13a-14, the Company hasput 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 believes that it has implemented adequate controls andprocedures for the preparation of this report.

 

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, continued 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 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 evaluatedisclosure controls on an ongoing basis.

 

Disclosure controls and procedures, no matter how well designed andimplemented, can provide only reasonable assurance of achieving an entity’sdisclosure objectives.  The likelihood ofachieving 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.

 

*Therewere no significant changes in the Company’s internal controls or in otherfactors that could significantly affect internal controls, known to the ChiefExecutive Officer or the Chief Financial Officer, subsequent to the date of theevaluation.*

 

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**BANCTEC, INC.**

**PART II**

**OTHER INFORMATION**

** **

**ITEM 1. Legal Proceedings**

 

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

 

**ITEM 2. Unregistered Sales of Equity Securities andUse of Proceeds**

** **

None

 

**ITEM 3. Defaults Upon Senior Securities**

** **

None

 

**ITEM 4. Submission of Matters to a Vote of Security Holders**

** **

None

 

**ITEM 5. Other Information**

 

None

 

**ITEM 6. Exhibits and Reports on Form 8-K**

 

(a)          Exhibits:

 

10.1 – SeventhAmendment to Loan and Security Agreement, dated as of May 14, 2005, betweenHeller Financial, Inc. and BancTec, Inc.

 

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 – Certificationof Chief Executive Officer pursuant to 18 USC 1350 and Rule15d-14(a) under the Sarbanes-Oxley Act

 

32.2 – Certificationof Chief Financial Officer pursuant to 18 USC 1350 and Rule15d-14(a) under the Sarbanes-Oxley Act

 

(b)         Reports onForm 8-K:

 

The Company filed a Current Report on Form 8-K dated February 18, 2005,regarding the termination of Brian R. Stone as Chief Financial Officer and theappointment of Jeffrey D. Cushman as Chief Financial Officer.

 

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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/ Jeffrey D. Cushman* | * * |
|                | *Jeffrey D. Cushman*                                                                 |
| * *            | *Senior Vice President on behalf of  the registrant and as Chief  Financial Officer* |
|                |
|                |
| Dated: May 20, 2005 |
|                     |                                                                                      |  |  |  |

 

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