**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****          ****Quarterly Report Pursuant to Section 13or 15(d) of the SecuritiesExchange Act of 1934**

 

**For thequarterly period ended September 30, 2005**

 

**OR**

 

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

 

**CommissionFile Number 0-9859**

 

**BANCTEC, INC.**

(Exact name of registrant asspecified in its charter)

 
| **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 allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.          Yes  ý    No  o

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes  o No  ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 
| ** **                                 | ** ** | **Number of Shares Outstanding at** | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|
| **Title of Each Class**                    | ** ** | **November 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 BALANCE SHEETS**

**(Inthousands, except share data)**

 
| ** **                                                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                           | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                                                           | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| CURRENT ASSETS:                                                                                                                      |       |                   |       |                  |       |
| Cash and cash equivalents, including restricted cash of $126 and  $4,056 at September 30, 2005 and December 31, 2004       |       | $                      | 24,195     |                  | $          | 51,487 |   |
| Accounts receivable, less allowance for doubtful accounts of  $1,109 and $931 at September 30,  2005 and December 31, 2004 |       | 46,600                 |       | 45,772                |       |
| Inventories, net                                                                                                                     |       | 23,669                 |       | 24,466                |       |
| Prepaid expenses                                                                                                                     |       | 6,247                  |       | 4,950                 |       |
| Other current assets                                                                                                                 |       | 2,005                  |       | 1,984                 |       |
| Total current assets                                                                                                                 |       | 102,716                |       | 128,659               |       |
|                                                                                                                                 |       |                   |       |                  |       |
| PROPERTY, PLANT AND EQUIPMENT,  net                                                                                                  |       | 29,903                 |       | 34,254                |       |
|                                                                                                                                 |       |                   |       |                  |       |
| OTHER ASSETS:                                                                                                                        |       |                   |       |                  |       |
| Goodwill                                                                                                                             |       | 41,476                 |       | 41,476                |       |
| Other Intangible Assets                                                                                                              |       | 2,238                  |       | —                |       |
| Deferred income tax benefit                                                                                                          |       | 6,829                  |       | 6,874                 |       |
| Other assets                                                                                                                         |       | 4,143                  |       | 4,802                 |       |
| Total other assets                                                                                                                   |       | 54,686                 |       | 53,152                |       |
|                                                                                                                                 |       |                   |       |                  |       |
| TOTAL ASSETS                                                                                                                         |       | $                      | 187,305    |                  | $          | 216,065 |   |
|                                                                                                                                 |       |                   |       |                  |       |
| CURRENT LIABILITIES:                                                                                                                 |       |                   |       |                  |       |
| Current obligations under capital leases and revolver                                                                                |       | $                      | 108        |                  | $          | 299 |   |
| Trade accounts payable                                                                                                               |       | 14,253                 |       | 14,479                |       |
| Other accrued expenses and liabilities                                                                                               |       | 36,044                 |       | 34,377                |       |
| Deferred revenue                                                                                                                     |       | 18,396                 |       | 23,778                |       |
| Maintenance contract deposits                                                                                                        |       | 32,865                 |       | 41,083                |       |
| Income taxes                                                                                                                         |       | 4,878                  |       | 3,112                 |       |
| Total current liabilities                                                                                                            |       | 106,544                |       | 117,128               |       |
|                                                                                                                                 |       |                   |       |                  |       |
| OTHER LIABILITIES:                                                                                                                   |       |                   |       |                  |       |
| Long-term debt                                                                                                                       |       | 197,823                |       | 197,823               |       |
| Non-current maintenance contract deposits                                                                                            |       | 13,084                 |       | 20,547                |       |
| Other non-current liabilities                                                                                                        |       | 22,374                 |       | 22,230                |       |
| Total other liabilities                                                                                                              |       | 233,281                |       | 240,600               |       |
|                                                                                                                                 |       |                   |       |                  |       |
| Total liabilities                                                                                                                    |       | 339,825                |       | 357,728               |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                        |       |                   |       |                  |       |
|                                                                                                                                 |       |                   |       |                  |       |
| SERIES A PREFERRED STOCK – issued and outstanding, 100,667 shares at September 30,  2005 and December 31, 2004        |       | 18,040                 |       | 18,040                |       |
|                                                                                                                                 |       |                   |       |                  |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                          |       |                   |       |                  |       |
| Cumulative preferred stock - authorized, 200,000 shares of $0.01 par  value at September 30, 2005 and December 31, 2004    |       |                   |       |                  |       |
| Series B preferred stock - issued and outstanding,  35,520 shares at September 30, 2005  and December 31, 2004        |       | 13,520                 |       | 13,520                |       |
| Common stock authorized, 21,800,000 shares of $0.01 par value at  September 30, 2005 and December 31,  2004:               |       |                   |       |                  |       |
| Common stock-issued and outstanding  17,003,838 shares at September 30, 2005  and December 31, 2004                   |       | 170                    |       | 170                   |       |
| Class A common stock-issued and outstanding 1,181,946 shares  At September 30, 2005 and December 31,  2004            |       | 12                     |       | 12                    |       |
| Subscription stock warrants                                                                                                          |       | 3,726                  |       | 3,726                 |       |
| Additional paid-in capital                                                                                                           |       | 122,655                |       | 122,655               |       |
| Accumulated deficit                                                                                                                  |       | (295,744               | )          | (286,247              | )          |
| Accumulated other comprehensive loss                                                                                                 |       | (14,899                | )          | (13,539               | )          |
| Total stockholders’ deficit                                                                                                     |       | (170,560               | )          | (159,703              | )          |
|                                                                                                                                 |       |                   |       |                  |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                    |       | $                      | 187,305    |                  | $          | 216,065 |   |

 

See notesto unaudited condensed consolidated financial statements.

 

2

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**BANCTEC, INC.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                              | ** ** | **Three  Months Ended****September 30,** | ** ** | **Nine  Months Ended****September 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                      | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **(In  thousands)**                           | ** ** | **(In  thousands)**                          | ** ** |
| REVENUE                                 |       |                                          |       |                                         |       |   |   |   |   |
| Equipment and software                  |       | $                                             | 24,875     |                                         | $          | 27,364 |   | $ | 90,685 |   | $ | 101,950 |   |
| Maintenance and other services          |       | 55,962                                        |       | 55,753                                       |       | 163,221 |   | 170,070 |   |
|                                    |       | 80,837                                        |       | 83,117                                       |       | 253,906 |   | 272,020 |   |
| COST OF SALES                           |       |                                          |       |                                         |       |   |   |   |   |
| Equipment and software                  |       | 14,631                                        |       | 18,912                                       |       | 53,447 |   | 66,345 |   |
| Maintenance and other services          |       | 45,202                                        |       | 46,259                                       |       | 134,282 |   | 140,501 |   |
|                                    |       | 59,833                                        |       | 65,171                                       |       | 187,729 |   | 206,846 |   |
|                                    |       |                                          |       |                                         |       |   |   |   |   |
| Gross profit                            |       | 21,004                                        |       | 17,946                                       |       | 66,177 |   | 65,174 |   |
|                                    |       |                                          |       |                                         |       |   |   |   |   |
| OPERATING EXPENSES                      |       |                                          |       |                                         |       |   |   |   |   |
| Product development                     |       | 2,296                                         |       | 1,833                                        |       | 7,127 |   | 6,396 |   |
| Selling, general and administrative     |       | 16,619                                        |       | 15,148                                       |       | 50,910 |   | 46,109 |   |
| Amortization of Other Intangible Assets |       | 107                                           |       | —                                       |       | 107 |   | — |   |
|                                    |       | 19,022                                        |       | 16,981                                       |       | 58,144 |   | 52,505 |   |
|                                    |       |                                          |       |                                         |       |   |   |   |   |
| Income from operations                  |       | 1,982                                         |       | 965                                          |       | 8,033 |   | 12,669 |   |
|                                    |       |                                          |       |                                         |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                 |       |                                          |       |                                         |       |   |   |   |   |
| Interest income                         |       | 164                                           |       | 193                                          |       | 592 |   | 484 |   |
| Interest expense                        |       | (4,766                                        | )          | (4,782                                       | )          | (14,278 | ) | (14,336 | ) |
| Sundry, net                             |       | 9                                             |       | 503                                          |       | (708 | ) | (1,489 | ) |
|                                    |       | (4,593                                        | )          | (4,086                                       | )          | (14,394 | ) | (15,341 | ) |
|                                    |       |                                          |       |                                         |       |   |   |   |   |
| LOSS BEFORE INCOME TAXES                |       | (2,611                                        | )          | (3,121                                       | )          | (6,361 | ) | (2,672 | ) |
| INCOME TAX EXPENSE                      |       | 454                                           |       | 328                                          |       | 3,136 |   | 3,248 |   |
| NET LOSS                                |       | (3,065                                        | )          | (3,449                                       | )          | (9,497 | ) | (5,920 | ) |
|                                         |            |                                               |            |                                              |            |  |  |  |  |  |  |  |  |

 

See notesto unaudited condensed consolidated financial statements.

 

3

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                                                      | ** ** | **(In  thousands)**                       | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES                                           |       |                                      |       |   |   |
| Net loss                                                                        |       | $                                         | (9,497     | ) | $ | (5,920 | ) |
| Adjustments to reconcile to cash flows provided by operations:                  |       |                                      |       |   |   |
| Depreciation and amortization                                                   |       | 11,390                                    |       | 12,461 |   |
| Provision for doubtful accounts                                                 |       | 125                                       |       | (159 | ) |
| Deferred income tax expense                                                     |       | 45                                        |       | 905 |   |
| Loss on disposition of property, plant and equipment and impairment             |       | 1,818                                     |       | 535 |   |
| Other non-cash items                                                            |       | 129                                       |       | 304 |   |
| Changes in operating assets and liabilities                                     |       |                                      |       |   |   |
| Increase in accounts receivable                                                 |       | (953                                      | )          | (5,206 | ) |
| (Increase) decrease in inventories                                              |       | (735                                      | )          | 1,200 |   |
| (Increase) decrease in other assets                                             |       | (589                                      | )          | 455 |   |
| Decrease in trade accounts payable                                              |       | (226                                      | )          | (1,037 | ) |
| Decrease in deferred revenue & maintenance contracts  deposits         |       | (21,063                                   | )          | (6,696 | ) |
| Increase in other accrued expenses and liabilities                              |       | 3,102                                     |       | 3,118 |   |
| Cash flows used in operating activities                                         |       | (16,454                                   | )          | (40 | ) |
|                                                                            |       |                                      |       |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES                                           |       |                                      |       |   |   |
| Purchases of property, plant and equipment                                      |       | (7,781                                    | )          | (5,421 | ) |
| Purchase of intangibles                                                         |       | (1,775                                    | )          | — |   |
| Proceeds from sale of property, plant and equipment                             |       | —                                    |       | 297 |   |
| Proceeds from sale of investment in unconsolidated subsidiary                   |       | —                                    |       | 2,955 |   |
| Cash flows used in investing activities                                         |       | (9,556                                    | )          | (2,169 | ) |
|                                                                            |       |                                      |       |   |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES                                           |       |                                      |       |   |   |
| Payments of current maturities of long-term debt and capital lease  obligations |       | (267                                      | )          | (865 | ) |
| Payments on short-term borrowings, net                                          |       | 2                                         |       | — |   |
| Debt issuance costs                                                             |       | (70                                       | )          | (50 | ) |
| Cash flows used in financing activities                                         |       | (335                                      | )          | (915 | ) |
|                                                                            |       |                                      |       |   |   |
| EFFECT OF EXCHANGE RATE CHANGES  ON CASH                                        |       | (947                                      | )          | 256 |   |
| NET DECREASE IN CASH AND CASH  EQUIVALENTS                                      |       | (27,292                                   | )          | (2,868 | ) |
| CASH AND CASH EQUIVALENTS—BEGINNING  OF YEAR                               |       | 51,487                                    |       | 61,566 |   |
|                                                                            |       |                                      |       |   |   |
| CASH AND CASH EQUIVALENTS—END  OF PERIOD                                   |       | $                                         | 24,195     |   | $ | 58,698 |   |
|                                                                            |       |                                      |       |   |   |
| SUPPLEMENTAL DISCLOSURES  INFORMATION:                                          |       |                                      |       |   |   |
| Cash paid during the period for:                                                |       |                                      |       |   |   |
| Interest                                                                        |       | $                                         | 11,514     |   | $ | 11,574 |   |
| Taxes                                                                           |       | $                                         | 1,091      |   | $ | 2,196 |   |

 

See notesto unaudited condensed consolidated financial statements.

 

4

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**BANCTEC,INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

BancTec, Inc. is a worldwide systems integration and servicescompany with a 30-year history in imaging technology, financial transactionprocessing and workflow productivity improvement.  Serving a variety of industries, includingbanking, financial services, insurance, healthcare, governmental agencies andothers, the Company offers a portfolio of payment and document processingsystems and services, workflow and image management software products, andcomputer and network support services.

 

The accompanying unaudited condensedconsolidated balance sheet at September 30, 2005, and the unauditedcondensed consolidated statements ofoperations and cash flows for the interim periods ended September 30, 2005and 2004, should be read in conjunction with BancTec, Inc. andsubsidiaries (“BancTec” or the “Company”) consolidated financial statements andnotes thereto in the most recent Annual Report on Form 10-K filed with theSecurities and Exchange Commission.  Inthe opinion of management, the accompanyingcondensed consolidated financial statements contain all materialadjustments, consisting principally of normal recurring adjustments, necessaryfor a fair presentation of the financial position and results of operations ofthe Company. All significant intercompany balances and transactions have beeneliminated in consolidation.

 

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

 

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

 

**Use of Estimates**

 

The preparation of the Company’s consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent assets and liabilities and the reported amounts ofrevenues, costs and expenses during the reporting period. Actual results coulddiffer from those estimates.

 

**Cash and Cash Equivalents andShort-Term Investments**

 

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 September 30,2005, of $0.1 million represents the cash pledged under the terms of theRevolving Credit Facility (See Note 8).

 

**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 approachincorporates both recent historical information and management estimates oftrends. The Company’s approach is intended to take into consideration potentialexcess and obsolescence caused by a decreasing installed base, engineeringchanges and end of manufacture.  If anyof the elements of the Company’s estimate were to deteriorate, additionalwrite-downs may be required. The inventory write-down calculations are reviewedperiodically and additional write-downs are recorded as deemed necessary.  Inventoryreserves as of September 30, 2005 and December 31, 2004, were $12.4million and $13.6 million, respectively. Inventory reserves establish a new cost basis for inventory and are notreversed in future 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 September 30, 2005 and 2004 was $3.9million and $4.7 million respectively. Depreciation expense for the nine months ended September 30, 2005and 2004 was $11.3 million and $12.5 million respectively.

 

**Revenue Recognition**

 

The Company derives revenue primarily from two sources: (1) productsales - systems integration solutions which address complex data andpaper-intensive work processes, including advanced web-enabled imaging andworkflow technologies with both BancTec and third-party hardware and software and (2) services - consist primarilyof application design, development and maintenance, all aspects of desktopoutsourcing, including field engineering, as well as help desk and LAN/WANnetwork outsourcing.

 

TheCompany’s revenue recognition policies are in accordance with Statement ofPosition (“SOP”) 97-2, *“Software RevenueRecognition,”* as amended by SOP 98-9, “*Modification of SOP 97-2,**SoftwareRevenue Recognition with Respect to Certain Transactions,”* StaffAccounting Bulletin (“SAB”) No. 104,*“RevenueRecognition,”* and Emerging Issues Task Force (“EITF”) No. 00-21,*“Revenue Arrangements with Multiple Deliverables.”* Inthe case of software arrangements that require significant production,modification, or customization of software, or the license agreement requiresthe Company to provide implementation services that are determined to beessential to other elements of the arrangement, the Company follows theguidance in SOP 81-1, *“Accounting forPerformance of Construction–Type and Certain Production–Type Contracts.”*

 

Inthe case of non-software arrangements, the Company applies EITF No. 00-21and revenues related to arrangements with multiple elements are allocated toeach element based on the element’s relative fair value.  Revenueallocated to separate elements is recognized for each element in accordancewith the accounting policies described below.  If the Company cannotaccount for items included in a multiple-element arrangement as separate unitsof accounting, they are combined and accounted for as a single unit ofaccounting and generally recognized as the undelivered items or services areprovided to the customer.  The Companyspecifically uses the residual method, under which revenue is recognized on thedelivered elements only when the remaining undelivered element is postcontractcustomer support (PCS).

 

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.

 

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

 

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.  Certain estimates are used inrecognizing revenue on a “per call” basis related to breakdown rates, contracttypes, calls related to specific contract types, contract periods.  The Company uses its best judgment to relatecalls to contracts.  In addition, asactual breakdown experience rates are compared to estimates, such estimates maychange over time and will result in adjustments to the amount of “per call”revenue.  During the quarter endedJune 30, 2004, the Company recorded revenue of $4.3 million reflecting anadjustment arising out of a change in accounting estimate related to servicerevenue.  The information used incomputing these estimates is partially provided by a customer, and since June 30,2004, this information has been provided to the Company on a more timely andaccurate basis, resulting in greater accuracy of these estimates.  The Company anticipates that futureadjustments, if necessary, related to these estimates will be immaterial to theresults of operations.  Thecurrent and non-current portions of these advances are shown as DeferredRevenue or Maintenance Contract Deposits on the Consolidated Balance Sheets.

 

**Research and Development**

 

Research and development costs are expensedas incurred.  Research and developmentcosts for the nine months ended September 30, 2005, and 2004, were $7.1million and $6.4 million respectively.

 

**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

 

6

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their respective tax bases and operating lossand tax credit carryforwards. The Company records valuation allowances relatedto its deferred income tax assets when, in the opinion of management, it ismore likely than not that some portion or all of the deferred income tax assetswill not be realized. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton 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 Opinion No. 25 (“APB No. 25”), Accounting for StockIssued to Employees. The Company has adopted the disclosure requirements ofStatement of Financial Accounting Standards No. 123 (“SFAS No. 123”),Accounting for Stock-Based Compensation.

 

2000 Stock Plan:

 

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

 

Incentive Options. During the year ended December 31,2004, the Company granted 1,419,500 incentive options.  During the nine months ended September 30,2005, 485,000 incentive options were granted. Under the Plan, incentive options are granted at a fixed exercise pricenot less than 100% of the fair value of the shares of stock on the date ofgrant (or 110% of the fair value in certain circumstances). A portion of theincentive options vest over a four-year period at 25% per year beginning January 2,2001; the remainder vest based on the performance of the Company. As a part ofan employee retention program, vesting of 20.0% of the performance-basedincentive options was accelerated in October 2000.

 

Non-qualified stock options. During the yearended December 31, 2004, the Company granted 50,000 non-qualifiedoptions.  During the nine months ended September 30,2005, 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 value of the shares ofstock on the date of grant. A portion of the non-qualified options vest over afour-year period at 25% per year beginning January 2, 2001; the remaindervest based on the performance of the Company. As a part of an employeeretention program, vesting of 20.0% of the performance-based incentive optionswas accelerated in October 2000.

 
| ** **                                   | ** ** | **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                                      |       | 485,000               |       | —                    |       | 9.25                                   |       |
| Forfeited                                    |       | (70,000               | )          | —                    |       | 9.25                                   |       |
| Options outstanding-September 30,  2005 |       | 2,190,240             |       | 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 September 30, 2005, options topurchase 2,222,000 shares were outstanding, of which 288,125 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 the fair value price on the measurement date.  All options granted in 2004 and 2005 wereissued at or above fair value price, and therefore no

 

7

----

 

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  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                            | ** ** | **(In  thousands)**                         | ** ** | **(In  thousands)**                        | ** ** |
| Net loss as reported                                                                                                  |       | $                                           | (3,065     | )                                          | $          | (3,449 | ) | $ | (9,497 | ) | $ | (5,920 | ) |
| Total  stock-based employee compensation expense determined under fair-value based  method for all awards, net of tax |       | (371                                        | )          | (3                                         | )          | (1,115 | ) | (42 | ) |
| Pro Forma net loss                                                                                                    |       | $                                           | (3,436     | )                                          | $          | (3,452 | ) | $ | (10,612 | ) | $ | (5,962 | ) |

 

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:

 
| ** **                    | ** ** | **Nine  Months Ended September 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| **Weighted Average**          | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Risk free interest rate       |       | 4.76                                      | %          | 3.96 | % |
| Expected life                 |       | 10 years                                  |       | 10 years |   |
| Expected volatility           |       | 0                                         |       | 0 |   |
| Fair value of options granted |       | $                                         | 3.47       |   | $ | 2.99 |   |
|                               |            |                                           |            |  |  |  |  |

 

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

 

## *Reclassification*

## * *

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

 

## *Impairment*

## * *

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

 

In October 2005, the Company sold a property located in Dallas,Texas at a net loss of $1.3 million.  Animpairment charge of $1.3 million was therefore recorded during the quarterended September 30, 2005.  Thischarge is reflected in Selling, General and Administrative in the CondensedConsolidated Statements of Operations.

 

## *Change in Accounting Estimate*

## * *

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

 

*Asset Purchases*

 

On July 29, 2005, the Company completedthe acquisition of certain assets of a product manufacturing enterprise for anet purchase price of $2.4 million, consisting of $0.5 million in non-competeagreements and $1.9 million in fixed assets and other intangibles, primarilycustomer lists.

 

8

----

 

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

 

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

 
| ** **                                                        | ** ** | **Nine Months Ended September  30,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                        | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **(In thousands)**                   | ** ** |
| Capital  lease obligation incurred for lease of computer hardware |       | $                                    | —     |   | $ | 241 |   |
| Inventory put in service as fixed asset                           |       | 1,529                                |       | 105 |   |
|                                                                   |            |                                      |            |  |  |  |  |

 

**5.****             INVENTORIES**

 

Inventory consists of the following:

 
| ** **       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|------------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **       | ** ** | **(In  thousands)**    | ** ** |
| Raw materials    |       | $                      | 5,536      |                  | $          | 6,686 |   |
| Work-in-progress |       | 5,329                  |       | 5,247                 |       |
| Finished goods   |       | 12,804                 |       | 12,533                |       |
|             |       | $                      | 23,669     |                  | $          | 24,466 |   |

 

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

 

Property, plant and equipment consist of thefollowing:

 
| ** **                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                 | ** ** | **(In  thousands)**    | ** ** |
| Land                                       |       | $                      | 2,860      |                  | $          | 2,860 |   |
| Field support spare parts                  |       | 36,539                 |       | 38,057                |       |
| Systems and software                       |       | 50,991                 |       | 51,802                |       |
| Machinery and equipment                    |       | 19,869                 |       | 21,517                |       |
| Furniture, fixtures and other              |       | 9,661                  |       | 11,924                |       |
| Buildings                                  |       | 26,346                 |       | 26,529                |       |
|                                       |       | 146,266                |       | 152,689               |       |
| Accumulated depreciation and  amortization |       | 116,363                |       | 118,435               |       |
| Property, plant and equipment,  net        |       | $                      | 29,903     |                  | $          | 34,254 |   |

 

9

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

 

Other accrued expenses and liabilitiesconsist of the following:

 
| ** **                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                              | ** ** | **(In  thousands)**    | ** ** |
| Salaries, wages and other  compensation |       | $                      | 14,150     |                  | $          | 10,081 |   |
| Accrued taxes, other than  income taxes |       | 3,746                  |       | 4,868                 |       |
| Accrued interest payable                |       | 4,963                  |       | 3,204                 |       |
| Accrued invoices and costs              |       | 2,245                  |       | 1,191                 |       |
| Other                                   |       | 10,940                 |       | 15,033                |       |
|                                    |       | $                      | 36,044     |                  | $          | 34,377 |   |

 

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

 

Debt and other obligations consist of thefollowing:

 
| ** **                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                    | ** ** | **(In  thousands)**    | ** ** |
| 7.5% Senior Notes, unsecured,  due 2008       |       | $                      | 93,975     |                  | $          | 93,975 |   |
| Sponsor Note, unsecured, due  2009            |       | 103,848                |       | 103,848               |       |
| Revolving Credit Facility,  secured, due 2006 |       | —                 |       | —                |       |
|                                          |       | 197,823                |       | 197,823               |       |
| Less: Current portion                         |       | —                 |       | —                |       |
|                                          |       | $                      | 197,823    |                  | $          | 197,823 |   |

 

Revolving Credit Facility.  TheCompany has a revolving credit facility (the “Revolver”) provided by HellerFinancial, Inc. (“Heller”), which 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 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 September 30,2005, the Company had a $0.003 million balance outstanding under the Revolverand no outstanding balance on letters-of-credit.  The balance remaining under the Revolver thatthe Company can draw was $ 17.8 million at September 30, 2005 ($ 21.8million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 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 1.0and (2) 1.25 to 1.0 (total rate increase of 0.50%) or decreased by 0.25%increments when the fixed charge coverage ratio is greater than (1) 1.75to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of0.75%).  The interest rate was remeasuredas of the effective date of September 1, 2003 under this amendment.  At September 30, 2005, the Company’sweighted average rate on the Revolver was 8.5% 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

 

10

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payments on certain indebtedness. Restricted cash at September 30, 2005 of $0.1 million representscash pledged 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 1.1to 1.0.  Effective March 31, 2005,the loan and security agreement was further amended to add a triggering eventfor the fixed charge 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 September 30, 2005, theCompany was in compliance with all covenants under the Revolver.

 

Senior Notes.  Interest on the Senior Notes is fixed at 7.5%and is due and payable in semi-annual installments. Payments began December 1,1998. The Notes contain covenants placing limitations on the Company’s abilityto permit subsidiaries to incur certain debts, incur certain loans, and engagein certain sale and leaseback transactions.  The estimated fair value of the SeniorNotes as of September 30, 2005, is approximately $66.9 million based on anaverage value of the most recently completed market trades, resulting in ayield-to-maturity of approximately 22.5%. The number of actual trades is limited; therefore, the result may varyif a widely traded market environment existed.

 

Subordinated Unsecured Sponsor Note.The Company’s Sponsor Note bears interest at 10.0%, due and payable quarterly.The Sponsor Note is subordinate only upon bankruptcy or insolvency of theCompany, or if upon maturity of the Senior Notes, the Senior Notes remainunpaid.  The payments began September 30,1999. As provided under the agreement, however, the Sponsor Note holder, Welsh,Carson, Anderson & Stowe (“WCAS’), elected to defer quarterly interestpayments of $4.0 million for each of the September 2000 through September 2001quarterly periods resulting in an increase in the principal amount of theSponsor Note totaling $33.8 million. Such election required a deferred financing-fee of 30.0% of each of theinterest payments being deferred.  TheCompany accounts for the additional financing fees as a change in the effectiveinterest rate of the debt. WCAS may, at its election, defer each futurequarterly payment under similar terms. WCAS has not elected to defer 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 principalpayment on the Sponsor Note.  Theestimated fair-value of the Sponsor Note and deferred interest and fees as of September 30,2005, is approximately $62.3 million assuming a yield-to-maturity of 27.5%.

 

The Company had no outstanding balances onforeign credit agreements at September 30, 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 liabilities section ofthe Condensed Consolidated Balance Sheets and the non-current portion ofcapital leases are included in Other Liabilities.  At September 30, 2005, the Company hadcapital lease balances outstanding of $0.2 million, of which $0.1 million wasclassified as current and $0.1 million was classified as long-term.

 

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

 

Beginning January 1, 2002, the Companyadopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwilland Other Intangible Assets”.  SFAS No. 142requires that goodwill and intangible assets with indefinite useful lives nolonger be amortized but instead be tested for impairment at leastannually.  SFAS No. 142 alsorequires that intangible assets with definite useful lives be amortized overtheir respective 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 valueto determine whether an indication of impairment exists. If impairment isindicated, then under the second step the fair value of the reporting unit’sgoodwill is determined by allocating the unit’s fair value to its assets andliabilities (including any unrecognized intangible assets) as if the reporting unithad 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 ninemonths ended September 30, 2005 or September 30, 2004.

 

11

----

 

**10.****          PENSIONBENEFITS**

 

Net periodic pension costs included the following components for thethree and nine months ended September 30:

 
| ** **                                 | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(In  thousands)**                         | ** ** | **(In  thousands)**                        | ** ** |
| Components of net periodic  benefits cost: |       |                                        |       |                                       |       |   |   |   |   |
| Service cost                               |       | $                                           | 201        |                                       | $          | 112 |   | $ | 402 |   | $ | 336 |   |
| Interest cost                              |       | 716                                         |       | 397                                        |       | 1,431 |   | 1,191 |   |
| Expected return on plan assets             |       | (494                                        | )          | (274                                       | )          | (988 | ) | (822 | ) |
| Recognized actuarial loss                  |       | 195                                         |       | 108                                        |       | 390 |   | 324 |   |
| Net periodic benefit cost                  |       | $                                           | 618        |                                       | $          | 343 |   | $ | 1,235 |   | $ | 1,029 |   |

 

*Company Contributions*

 

The Company previously disclosed in its financialstatements for the year ended December 31, 2004, that it expected tocontribute $1.3 million to the pension plan during 2005.  As of September 30, 2005, $1.2 millionof contributions have been made.  TheCompany presently anticipates continuing its contributions to the pension planto total $1.7 million for 2005.

 

**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):

 
| ** **                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                            | ** ** | **(In  thousands)**    | ** ** |
| Gross deferred tax assets:            |       |                   |       |                  |       |
| Net operating losses                  |       | $                      | 55,334     |                  | $          | 47,335 |   |
| AMT credit carryforwards              |       | 101                    |       | 101                   |       |
| Inventory reserves                    |       | 4,593                  |       | 4,948                 |       |
| Receivable allowance                  |       | 269                    |       | 205                   |       |
| Intangible assets previously deducted |       | 578                    |       | 905                   |       |
| Deferred revenues                     |       | 12,670                 |       | 15,450                |       |
| Deferred compensation                 |       | 3,106                  |       | 2,639                 |       |
| Foreign timing differences, net       |       | 8,896                  |       | 9,088                 |       |
| Other                                 |       | 4,703                  |       | 5,723                 |       |
| Total gross deferred tax asset        |       | 90,250                 |       | 86,394                |       |
| Gross deferred tax liabilities:       |       |                   |       |                  |       |
| Depreciation                          |       | (1,793                 | )          | (1,352                | )          |
| Total gross deferred tax liability    |       | (1,793                 | )          | (1,352                | )          |
| Deferred tax asset valuation  reserve |       | (79,644                | )          | (76,184               | )          |
| Net deferred tax asset                |       | $                      | 8,813      |                  | $          | 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.

 

12

----

 

Components of the valuation allowance are as follows:

 
| ** **                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(In thousands)**                       | ** ** |
| Valuation allowance at beginning of year  |       | $                                        | 76,184     |   | $ | 63,874 |   |
| (Release) Increase in valuation allowance |       | (634                                     | )          | (5,903 | ) |
| Income from continuing operations         |       | 3,925                                    |       | (857 | ) |
| Return to provision adjustments           |       | 169                                      |       | (2,032 | ) |
| Valuation allowance at end of period      |       | $                                        | 79,644     |   | $ | 55,082 |   |

 

Undistributed earnings of foreignsubsidiaries included in continuing operations were approximately $ 16.4million and $17.7 million at September 30, 2005 and December 31,2004, respectively.  No taxes have beenprovided on the undistributed earnings as they are considered to be permanentlyreinvested.

 

**12.****          WARRANTY LIABILITY**

 

The Company 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.

 

Changes to the Company’s warranty liability, which is reported as acomponent of other accrued expenses and liabilities in the accompanyingcondensed consolidated balance sheet during the nine months ended September 30,2005 are summarized as follows:

 
| ** **                                        | ** ** | **(In  thousands)** | ** ** |
|---------------------------------------------------|------------|---------------------|------------|
| Balance at December 31, 2004                 |       | $                   | 180        |   |
| Warranties issued                                 |       | 172                 |       |
| Claims paid/settlements                           |       | (116                | )          |
| Changes in liability for pre-existing  warranties |       | —              |       |
| Balance at September 30, 2005                |       | $                   | 236        |   |

 

**13.****          COMPREHENSIVELOSS**

 

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

 
| ** **                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                               | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In thousands)**                         | ** ** | **(In thousands)**                        | ** ** |
| Net loss                                 |       | $                                          | (3,065     | )                                         | $          | (3,449 | ) | $ | (9,497 | ) | $ | (5,920 | ) |
| Foreign currency translation adjustments |       | (90                                        | )          | 3                                         |       | (1,360 | ) | 315 |   |
| Total  comprehensive loss                |       | $                                          | (3,155     | )                                         | $          | (3,446 | ) | $ | (10,857 | ) | $ | (5,605 | ) |

 

13

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**14.****          BUSINESS SEGMENT 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, NAOPS includes the operations of the Company’sCanadian operations and the operations of Plexus® products (“Plexus”) that werepreviously reported in International Solutions. The operations of Plexus and Canada are not material to EUOPS or toNAOPS.  Under the new structure thecomposition of CNS remains unchanged. Prior period information has been reclassified to reflect the newalignment.

 
| ** **                                         | ** ** | **North  American  Operations** | ** ** | **Computer  & Network  Services** | ** ** | **European  Operations** | ** ** | **Corp/Elims** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|--------------------------|------------|----------------|------------|-----------|------------|
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| For the three months ended September 30, 2005 |       |                            |       |                                  |       |                     |       |           |       |      |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| Revenue from external customers                    |       | $                               | 25,319     |                                  | $          | 32,672                   |       | $              | 22,846     |      | $          | — |   | $ | 80,837 |   |
| Intersegment revenue                               |       | 1,528                           |       | —                                |       | 1,741                    |       | (3,269         | )          | —    |       |
| Segment gross profits                              |       | 9,612                           |       | 3,847                                 |       | 7,543                    |       | 2              |       | 21,004    |       |
| Segment operating income (loss)                    |       | 4,250                           |       | 2,345                                 |       | 1,662                    |       | (6,275         | )          | 1,982     |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| For the three months ended September 30, 2004 |       |                            |       |                                  |       |                     |       |           |       |      |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| Revenue from external customers                    |       | $                               | 27,075     |                                  | $          | 32,363                   |       | $              | 23,679     |      | $          | — |   | $ | 83,117 |   |
| Intersegment revenue                               |       | 1,509                           |       | —                                |       | 1,750                    |       | (3,259         | )          | —    |       |
| Segment gross profits                              |       | 7,937                           |       | 3,137                                 |       | 7,138                    |       | (266           | )          | 17,946    |       |
| Segment operating income (loss)                    |       | 2,268                           |       | 786                                   |       | 902                      |       | (2,991         | )          | 965       |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| For the nine months ended September 30, 2005  |       |                            |       |                                  |       |                     |       |           |       |      |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| Revenue from external customers                    |       | $                               | 82,326     |                                  | $          | 94,004                   |       | $              | 77,576     |      | $          | — |   | $ | 253,906 |   |
| Intersegment revenue                               |       | 4,590                           |       | —                                |       | 4,729                    |       | (9,319         | )          | —    |       |
| Segment gross profits                              |       | 29,194                          |       | 9,327                                 |       | 27,693                   |       | (37            | )          | 66,177    |       |
| Segment operating income (loss)                    |       | 12,201                          |       | 5,032                                 |       | 8,925                    |       | (18,125        | )          | 8,033     |       |
| Segment identifiable assets                        |       | 83,724                          |       | 26,122                                |       | 40,803                   |       | 36,656         |       | 187,305   |       |
| Capital appropriations                             |       | 2,481                           |       | 2,110                                 |       | 2,032                    |       | 2,687          |       | 9,310     |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| For the nine months ended September 30, 2004  |       |                            |       |                                  |       |                     |       |           |       |      |       |
|                                               |       |                            |       |                                  |       |                     |       |           |       |      |       |
| Revenue from external customers                    |       | $                               | 94,043     |                                  | $          | 97,714                   |       | $              | 80,263     |      | $          | — |   | $ | 272,020 |   |
| Intersegment revenue                               |       | 4,538                           |       | —                                |       | 4,156                    |       | (8,694         | )          | —    |       |
| Segment gross profits                              |       | 27,362                          |       | 11,856                                |       | 26,466                   |       | (510           | )          | 65,174    |       |
| Segment operating income (loss)                    |       | 8,823                           |       | 4,524                                 |       | 8,509                    |       | (9,187         | )          | 12,669    |       |
| Segment identifiable assets                        |       | 77,828                          |       | 25,492                                |       | 49,977                   |       | 75,429         |       | 228,726   |       |
| Capital appropriations                             |       | 1,837                           |       | 1,797                                 |       | 1,210                    |       | 923            |       | 5,767     |       |
|                                                    |            |                                 |            |                                       |            |                          |            |                |            |           |            |  |  |  |  |  |  |  |  |

 

**15.****          PREFERRED STOCK**

 

**SERIES A PREFERRED STOCK**

 

The Company allocated the proceeds from its Series Apreferred stock issuance based upon the relative fair value of the preferredstock and warrants issued.  The relateddiscount 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 nine months ended September 30, 2005. As of September 30, 2005, the stated value of the Series A preferred stock, includingaccumulated but unpaid dividends, was $201.32 per share.

 

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**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 aresult, no dividends were accrued during the nine months ended September 30,2005.  As of September 30,2005, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $380.63 pershare.

 

**16.****          RECENT ACCOUNTING PRONOUNCEMENTS**

 

On December 16, 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment*.*” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123R eliminates theability to account for share-based compensation transactions using AccountingPrinciples Board Opinion No. 25 and generally requires that suchtransactions 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 final impact of this standard onthe company’s consolidated results of operations, financial position, and cashflows. This assessment includes evaluating option valuation methodologies andassumptions as well as potential changes to the Company’s compensationstrategies.

 

In December 2004, the FASB issued SFAS No. 151, “InventoryCosts, an amendment of ARB No. 43, Chapter 4,”**whichwill become effective for the Company beginning January 1, 2006. Thisstandard clarifies that abnormal amounts of idle facility expense, freight,handling costs and wasted material should be expensed as incurred and notincluded in overhead. In addition, this standard requires that the allocationof fixed production overhead costs to inventory be based on the normal capacityof the production facilities. The Company is currently evaluating the potentialimpact of this standard on its financial position and results of operations,but does not believe the impact of 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 ofFASB Statement No. 109, Accounting for Income Taxes, to the Tax Deductionon Qualified Production Activities Provided by the American Jobs Creation Actof 2004” and FSP 109-2—”Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004,”**which became 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, anybenefit from the deduction will be reported in the period in which the deductionis claimed 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 law changes inthe period of enactment. FSP 109-2 provides companies additional time todetermine the amount of earnings, if any, that they intend to repatriate underthe Jobs Creation Act’s provisions.  Asof September 30, 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.

 

**17.   SUBSEQUENT EVENTS**

 

None

 

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**ITEM 2. MANAGEMENT’S DISCUSSIONAND ANALYSIS OF 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 Form 10-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 or impliedby such forward-looking statements. All statements other than statements ofhistorical fact are statements that could be deemed forward-looking statements,including any projections of earnings, revenues, or other financial items; anystatements of the plans, strategies, and objectives of management for futureoperations; any statements concerning proposed new products, services, ordevelopments; any statements regarding future economic conditions orperformance; statements of belief and any statement of assumptions underlyingany of the foregoing. The risks, uncertainties and assumptions referred toabove include the ability of the Company to retain and motivate key employees;the timely development, production and acceptance of products and services andtheir feature sets; the challenge of managing asset levels, includinginventory; the flow of products into third-party distribution channels; thedifficulty of keeping expense growth at modest levels while increasingrevenues; and other risks that are described from time to time in the Company’sSecurities and Exchange Commission reports, including but not limited to theitems discussed in “Factors Affecting the Company’s Business and Prospects” setforth in this report, and items described in the Company’s other filings withthe Securities and Exchange Commission. The Company undertakes no obligation toupdate or revise forward-looking statements to reflect changes in assumptions,the occurrence of unanticipated results or changes to future operating resultsover time.*

* *

**Overview**

 

The Company believes severalfactors continued to create a challenging and competitive sales andcost-containment environment during the nine months ended September 30,2005.  These factors include: generaleconomic conditions and reduced corporate customer technology spending; ongoingcompetitive pressures; an ongoing planned change in revenue mix within theCompany’s North American Operations (“NAOPS”) and European Operations (“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 nine months ended September 30, 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 and earningsgrowth prospects.  Most of the Company’sproduct 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.

 

**RESULTS OF OPERATIONS**

 

**Comparison of Three MonthsEnded September 30, 2005 and Three Months Ended September 30, 2004**

 

Consolidated revenue of $80.8 million for thethree months ended September 30, 2005 decreased by $2.3 million or 2.8%from the comparable prior-year period. The North American Operations (“NAOPS”) revenue decrease of $1.8 millionwas partially related to a decline in maintenance revenue due to the Company’sinstalled products reaching the end of their useful lives and from increasedcompetition.  The Company expects thesetrends to continue on these end-of-life products.  In addition, a decline in revenues related tothe sale and installation of hardware and software products was primarilyrelated to a weak market for payments solutions due to market trends, includingreduced check volume, check truncation, and the recent passage of Check21.  Decreases in European Operations (“EUOPS”)of $0.9 million are the result of decreased sales in Europe of ECM solutionscompared with the prior year’s period offset by the impact of the weakeneddollar on the conversion of revenue stated in foreign currencies.  Computer & Network Services (“CNS”)revenue increased $0.3 million with the comparable prior-year period.  Revenue decreases resulting from pricingdecreases, domestic competitive pressure, and decreased volume under certainmaintenance programs were offset by revenue increases from the expansion by CNSof operations in Europe.  Factorsexpected to impact future revenue include corporate-

 

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customer spending for largesystems-solutions, the continued impacts of check truncation, on-goingcompetitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $21.0 millionincreased by $3.1 million or 17.3% from the comparable prior-year period.  Gross profit increased by $1.7 million or21.5% for NAOPS, increased by $0.7 million or 22.6% for CNS and increased by$0.4 million or 5.6% for EUOPS.  Althoughrevenue decreased in NAOPS, the impact to gross profit was offset by anincrease in the NAOPS gross profit percentage as a result of ongoing cost-containmentefforts aimed at improving efficiency in the maintenance organization. TheNAOPS gross margin percentage increased from 27.6% to 35.8%.  Although revenue decreased in EUOPS, thegross profit impact was offset by an increase in the gross profit margin.  The EUOPS gross margin percentage increasedfrom 27.8% to 30.6%.  Continued effortsto provide proven 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 9.6% to 11.6%.  CNSis the major component in the maintenance and other services category on theConsolidated Statements of Operations, and therefore is a significantcontributing factor in the increased gross profit in the maintenance and otherservices category.

 

Operating expenses of $19.0 million increased$2.0 million compared to the prior-year period. Product-development expenses increased by $0.5 million or 27.8%primarily due to the timing of research projects.  Selling, general and administrative expenses(“SG&A”) increased by $1.5 million. $1.3 million of this increase results from the recognition of awrite-down in the current year period of the company’s investment in a facilityin Dallas, Texas to fair market value that had been previously vacated andoffered for sale.  Excluding thisone-time expense, SG&A increased 1.3% 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.  Amortization ofother intangible asset expense of $0.1 million was recognized in the currentyear period.  No amortization of otherintangible asset expense was recognized in the prior year’s period.

 

Interest expense for the threemonths ended September 30, 2005of $4.8 million was unchanged from thecomparable prior-year period.

 

Sundry items resulted in a net gain for the three months ended September 30,2005, of $0.01 million compared to a net gain of $0.5 million during thecomparable prior-year period.  The gainin both years was primarily the result of foreign exchange gains.

 

An income tax provision of $0.5 million for the three months ended September 30, 2005 is compared to a correspondingprior-year period income tax provision of $0.3 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 (19.2)% for the three months ended September 30, 2005 as compared to (9.7)% for thecorresponding prior-year period.

 

**Comparison of Nine Months EndedSeptember 30, 2005 and Nine Months Ended September 30, 2004**

 

Consolidated revenue of $253.9 million forthe nine months ended September 30, 2005 decreased by $18.1 million or 6.7%from the comparable prior-year period. The North American Operations (“NAOPS”) revenue decrease of $11.7million was partially related to a decline in maintenance revenue due to theCompany’s installed products reaching the end of their useful lives and fromincreased competition.  The Companyexpects these trends 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 primarilyrelated to a weak market for payments solutions due to market trends, includingreduced check volume, check truncation, and the recent passage of Check21.  Decreases in European Operations (“EUOPS”)of $2.7 million are the result of decreased sales in Europe of ECM solutionscompared with the prior year’s period offset by the impact of the weakeneddollar on the conversion of revenue stated in foreign currencies.  A decrease in Computer & NetworkServices (“CNS”) of $3.7 million resulted from the revenue adjustment of $4.3million in the prior-year period, reflecting a change in accounting estimaterelated to deferred revenue.  This waspartially offset by revenue increases from the expansion by CNS of operationsin Europe.  Factors expected to impactfuture revenue include corporate-customer spending for large systems-solutions,the continued impacts of check truncation, on-going competitive pressures, andfluctuations in international currencies.

 

Consolidated gross profit of $66.2 millionincreased by $1.0 million or 1.5% from the comparable prior-year period.  Gross profit increased by $1.8 million or 6.6%for NAOPS, decreased by $2.6 million or 21.8% for CNS and increased by $1.2million or 4.5% for EUOPS.  Althoughrevenue decreased in NAOPS, the impact to gross profit was offset by anincrease in the NAOPS gross profit percentage as a result of ongoing cost-containmentefforts aimed at improving efficiency in the maintenance organization. TheNAOPS gross margin percentage increased from 27.8% to 33.6%.  Increases in EUOPS gross profit resulted froman improved gross margin percentage, despite decreased revenues.  The EUOPS gross margin percentage increasedfrom 31.4% to 33.7%.  Continued effortsto provide proven 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 percentagedecreased from 12.2% to 9.9%, primarily due to the revenue adjustment of $4.3million

 

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recorded in the prior-year period reflectinga change in accounting estimate on deferred revenue.  CNS is the major component in the maintenanceand other services category on the Consolidated Statements of Operations, andtherefore is a significant contributing factor in the increased gross profit inthe maintenance and other services category.

 

Operating expenses of $58.1 million increased$5.6 million compared to the prior-year period. Product-development expenses increased by $0.7 million or 10.9%primarily due to the timing of research projects.  Selling, general and administrative expenses(“SG&A”) increased by $4.8 million or 10.4%.  $1.3million of this increase results from the recognition of a write-down in thecurrent year period of the company’s investment in a facility in Dallas, Texasto fair market value that had been previously vacated and offered forsale.  Excluding this one-time expense,SG&A increased $3.5 million primarily due to increased marketingactivities related to an expansion and refocus of the corporate marketingstrategy, increased sales expense resulting from an expansion of the salesforce to support new product strategies, and increased depreciationexpense.  Amortization of other intangibleasset expense of $0.1 million was recognized in the current year period.  No amortization of other intangible assetexpense was recognized in the prior year’s period.

 

Interest expense for the ninemonths ended September 30, 2005of $14.3 million was unchanged from thecomparable prior-year period.

 

Sundry items resulted in a net loss for the nine months ended September 30,2005, of $0.7 million compared to a net loss of $1.5 million for the comparableprior-year period.  Foreign exchangelosses of $0.7 million, compared with foreign exchange losses of $0.3 millionand the $1.3 million loss on the sale of the Company’s investment in the stockof Servibanca S.A. in the comparable prior year period.

 

An income tax provision of $3.1 million for the nine months ended September 30, 2005 is compared to a correspondingprior-year period income tax provision of $3.2 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 (48.4)% for the nine months ended September 30, 2005 as compared to (118.5)% for thecorresponding prior-year period.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The Company’s working capitaland capital expenditure requirements are generally provided by cash and cashequivalents, funds available under the Company’s revolving credit agreement, asdiscussed below, which will mature May 30, 2006, and by internallygenerated funds from cash flows from operations. Funds availability under therevolving credit agreement is determined by a borrowing-base formula equal to aspecified 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 a material impact on the Company’sfuture liquidity.  The Company believes,however, that these sources will be sufficient to support operations and capitalexpenditure needs during the next twelve months.

 

The Company’s cash and cash equivalentstotaled $24.2 million at September 30, 2005, compared with $51.5 million at December 31,2004. Working capital decreased $15.2 million during the nine months ended September 30,2005 to working deficit of $(3.7) millioncompared to working capital of $11.5 million at December 31, 2004.  The change in working capital included acurrent liability decrease of $10.7 million resulting from $13.6 milliondecrease in deferred revenue and maintenance contract deposits, anincrease in accrued liabilities of $1.7 million, an increase in income taxliabilities of $1.8 million, an accountsreceivable increase of $0.8 million, an inventory decrease of $0.8 million anda prepaid expense increase of $1.3 million. The decrease in deferred revenue and maintenance contract deposits hasresulted from decreased numbers of multi-year contracts for which up frontpayment is received, as well as decreased revenues from these contracts due tocompetitive pressure.

 

During the nine months ended September 30,2005, the Company relied primarily on cashreserves to fund operations. At September 30, 2005, the Company had available $21.8 million ofborrowing capacity under the Revolver, of which the Company can draw $17.8million.

 

Operating activities utilized $16.5 millionand less than $0.1 million of cash in the nine months ended September 30,2005 and 2004, respectively, a decrease of$16.5 million.  The net loss increased$3.5 million from the prior-year period. In addition, cash utilized by changes in working capital assets andliabilities was $12.4 million more than in the prior-year period.

 

Investing activities used net cash of $9.6million and $2.2 million in the nine months ended September 30,2005 and 2004, respectively. The uses ofcash during the nine months ended September 30, 2005, consisted ofpurchases of property, plant and equipment of $7.8 million and the purchase ofintangible assets of $1.8 million.  Theuses of cash during the nine months ended September 30, 2004, consisted ofpurchases of property, plant and equipment of $5.4 million, offset by cashreceived from the sale of the Company’s interest in Servibanca S.A. of $3.0million.

 

Financing activities used $0.3 million and$0.9 million for each of the nine months ended September 30,2005 and 2004, respectively.  Both uses of cash related primarily to thereduction of the Company’s debt and capital lease obligations.

 

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At September 30, 2005, the Company’s principal outstanding debtinstruments consisted of (i) no balance outstanding under the revolvingcredit facility maturing May 30, 2006 (which is more fully describedbelow), (ii)  $94.0 million of 7.5% Senior Notes due 2008, and (iii) $103.8million of Sponsor Notes due 2009. The Company or its affiliates may from timeto time purchase, redeem or pay deferred interest on some of its outstandingdebt or equity securities.  The Companywould only make these payments in compliance with the covenants of its debtinstruments.

 

The Company continually reviewsits various lines of business to assess their contribution to the Company’sbusiness plan and from time to time considers the sale of certain assets inorder to raise cash or reduce debt. Accordingly, the Company from time to time has explored and may explorepossible asset sales by seeking expressions of interest from potentialbidders.  However, the Company has notentered into any binding agreements or agreements in principle to sell anyassets and there can be no assurance that any such asset sales will occur or,if they occur, as to the timing or amount of proceeds that such asset sales maygenerate.

 

**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,the Company and Heller entered into an amendment to the Revolver which reducedthe committed 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 September 30, 2005, the Company had a $0.003 million balanceoutstanding under the Revolver and no outstanding balance onletters-of-credit.  The balance remainingunder the Revolver that the Company can draw was $17.8 million at September 30,2005 ($21.8 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 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 1.0and (2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by0.25% increments when the fixed charge coverage ratio is greater than (1) 1.75to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of0.75%).  The interest rate was remeasuredas of the effective date of September 1, 2003 under this amendment.  At September 30, 2005, the Company’sweighted average rate on the Revolver was 8.5% 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 September 30, 2005 of $0.1 million representscash pledged 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 to1.1 to 1.0.  Effective March 31,2005, the loan and security agreement was further amended to add a triggeringevent for the fixed charged coverage ratio covenant.  No fixed charge coverage ratio covenantapplies when cash balances exceed $20 million and the outstanding balance onthe revolver is less than $250,000.  Ifeither of these conditions is not met, then the fixed charge covenant ratiorequirement becomes 1.1 to 1.0.  At September 30,2005, the Company was in 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 Rule 144Aprivate offering. Interest is fixed at 7.5% and is due and payable insemi-annual installments, which began December 1, 1998. The Senior Notesmature on June 1, 2008.  The SeniorNotes contain 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**.The Company’s Sponsor Note bears interest at 10.0%, due and payable quarterly.The Sponsor Note is subordinate only upon bankruptcy or insolvency of theCompany, or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999.The Sponsor 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 the September 2000through September 2001 quarterly periods resulting in an increase in theprincipal amount of the Sponsor Note totaling $33.8 million.  Such election required a deferredfinancing-fee of 30.0% of each of the interest payments being deferred.  The Company accounts for the additionalfinancing fees as a change in the effective interest rate of the debt. WCASmay, at its election, defer each future quarterly payment under similarterms.  WCAS has not elected to defer thequarterly payments since

 

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September 2001.  Inaccordance with the terms of the Sponsor Note, on December 6, 2002, theCompany made a $90.0 million principal payment on the Sponsor Note.

 

**Preferred Stock – Series A**.****The Companyallocated the proceeds from its Series A preferred stock issuance basedupon the 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 nine months ended September 30,2005.  As of September 30,2005, the stated value of the Series Apreferred stock, including accumulated but unpaid dividends, was $201.32 pershare.

 

**Preferred Stock – Series B**.****Effective January 1,2005, the Series B Preferred Stock agreement was amended to eliminate thedividends payable on the Series B Preferred Stock.  As a result, no dividends were accrued duringthe nine months ended September 30, 2005. As of June 30, 2005, thestated value of the Series B preferred stock, including accumulated butunpaid dividends, was $380.63 per share.

 

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

 

### **Contractual Obligations and CommercialCommitments.**

###  

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 September 30,2005:

 
| ** **                         | ** ** | **Total  Amounts** | ** ** | **Less than****1 Year** | ** ** | **1-3****Years** | ** ** | **4-5****Years** | ** ** | **Over 5  Years** | ** ** |
|------------------------------------|------------|--------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|
|                               |       | **(In  Millions)** |       |
| Long-term debt                     |       | $                  | 197.8      |                    | $          | —           |       | $                | 94.0       |              | $          | 103.8 |   | $ | — |   |
| Capital leases                     |       | 0.2                |       | 0.1                     |       | 0.1              |       | —           |       | —            |       |
| Purchase Obligations               |       | 2.0                |       | 0.7                     |       | 1.3              |       | —           |       | —            |       |
| Operating leases  (non-cancelable) |       | 12.2               |       | 4.8                     |       | 5.1              |       | 1.3              |       | 1.0               |       |
| Total Contractual                  |       | 212.2              |       | 5.6                     |       | 100.5            |       | 105.1            |       | 1.0               |       |
|                               |       |               |       |                    |       |             |       |             |       |              |       |
| Unused lines of credit             |       | $                  | 17.8       |                    | $          | 17.8             |       | $                | —     |              | $          | — |   | $ | — |   |
| Standby letters of credit          |       | —             |       | —                  |       | —           |       | —           |       | —            |       |
| Total Commercial                   |       | $                  | 17.8       |                    | $          | 17.8             |       | $                | —     |              | $          | — |   | $ | — |   |
|                                    |            |                    |            |                         |            |                  |            |                  |            |                   |            |  |  |  |  |  |  |  |

 

*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, or variableprice provisions: and the approximate timing of the transaction.  Purchase obligations do not include contractsthat may be cancelled without penalty.

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

On December 16, 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment*.*” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123R eliminates theability to account for share-based compensation transactions using AccountingPrinciples Board Opinion No. 25 and generally requires that suchtransactions 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 final impact of this standard onthe company’s consolidated results of operations, financial position, and cashflows. This assessment includes evaluating option valuation methodologies andassumptions as well as potential changes to the Company’s compensationstrategies.

 

In December 2004, the FASB issued SFAS No. 151, “InventoryCosts, an amendment of ARB No. 43, Chapter 4,”**whichwill become effective for the Company beginning January 1, 2006. Thisstandard clarifies that abnormal amounts of idle facility expense, freight,handling costs and wasted material should be expensed as incurred and notincluded in overhead. In addition, this standard requires that the allocationof fixed production overhead costs to inventory be based on the normal capacityof the production facilities. The Company is currently evaluating the potentialimpact of this standard on its financial position and results of operations,but does not believe the impact of the change will be material.

 

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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 ofFASB Statement No. 109, Accounting for Income Taxes, to the Tax Deductionon Qualified Production Activities Provided by the American Jobs Creation Actof 2004” and FSP 109-2—”Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004,”**which became 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, anybenefit from the deduction will be reported in the period in which thededuction is claimed 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 law changes inthe period of enactment. FSP 109-2 provides companies additional time todetermine the amount of earnings, if any, that they intend to repatriate underthe Jobs Creation Act’s provisions.  Asof September 30, 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 ANDPROSPECTS**

 

Information provided by the Company in this Quarterly Report on Form 10-Qand other documents filed with the Securities and Exchange Commission include “forward-looking”information, as that term is defined in the Private Securities LitigationReform Act of 1995 (the “PSLRA”). Allstatements other than statements of historical fact are statements that couldbe 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.

 

***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

 

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delivery schedules (which can adversely affect the Company’smanufacturing efficiencies) and increases in component costs (which canadversely 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 reliable suppliescould result in delays and a possible loss of sales, which could affectoperating results adversely.

 

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

 

As a result of the Company’s high debt to equityratio, the Company is required 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 ANDQUALITATIVE DISCLOSURE ABOUT MARKET RISK.**

 

The Company utilizes long-term fixed rate andshort-term variable rate borrowings to finance the working capital and capitalrequirements of the business. At September 30, 2005 and December 31,2004, the Company had outstanding Senior Notes, due in 2008, of $94.0 million,with a fixed interest rate of 7.5%. At September 30, 2005 and December 31,2004, the Company also had the Sponsor Note, due 2009, with a balance of $103.8million. The Sponsor Note bears interest at a fixed rate of 10.0%.  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%over prime or (2) 2.75% over LIBOR. Although no substantial actualbalances were outstanding under the Revolver at September 30, 2005,assuming $1.0 million in borrowings under the Revolver, a one hundred basispoint change in the bank’s prime or LIBOR rate would impact net interestexpense by $10,000 over a twelve-month period.

 

The Company’s international subsidiariesoperate in approximately 11 countries and use the local currencies as thefunctional currency and the U.S. dollar as the reporting currency. Transactionsbetween the Company and the international subsidiaries are denominated in U.S.dollars. As a result, the Company has certain exposures to foreign currencyrisk. However, management believes that such exposure does not present asignificant risk due to a relatively limited number of transactions andoperations denominated in foreign currency.

 

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**ITEM 4. CONTROLS ANDPROCEDURES.**

 

As of the end of the period covered by this report, September 30,2005, the Chief Executive Officer and the Chief Financial Officer of theCompany, with the participation of the Company’s management, evaluated theeffectiveness of the Company’s disclosure controls and procedures pursuant toExchange Act Rule 13a-14.  Basedupon this evaluation, the Chief Executive Officer and the Chief FinancialOfficer believe that the Company’s disclosure controls and procedures areeffective in making known to them material information relating to the Company(including its consolidated subsidiaries) required to be included in thisreport.  In addition, the disclosurecontrols and procedures are effective to ensure that information required to bedisclosed in this report is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms and such information required to be disclosed is accumulated andcommunicated to management as appropriate to allow timely decisions regardingrequired disclosure.  The Company willcontinue to evaluate disclosure 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.  The Company’s disclosurecontrols and procedures are designed to provide reasonable assurance ofachieving their objectives, and the Chief Executive Officer and Chief FinancialOfficer believe that the Company’s disclosure controls and procedures areeffective at that reasonable assurance level.

 

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

 

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**BANCTEC,INC.**

**PART II**

**OTHERINFORMATION**

 

**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 onForm 8-K**

 

(a)          Exhibits:

 

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

 

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

 

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

 

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

 

(b)         Reports onForm 8-K:

 

None

 

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**SIGNATURES**

 

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

 

**BancTec, Inc.**

 

 
| * * | *By*     | */s/ Jeffrey D. Cushman*                                                                               |   |
|----------|----------|--------------------------------------------------------------------------------------------------------|--------|
| * * | * * | *Jeffrey D. CushmanSenior Vice President on behalf of  the registrant and as Chief  Financial Officer* |
|          |          |                                                                                                        |        |  |

 

 

Dated: November 18, 2005

 

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