**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

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

 

**For thequarterly period ended September 30, 2004**

 

**OR**

 

**o****        TransitionReport Pursuant to Section 13 or 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) 579-6000**                                              |
| (Registrant’s  telephone number, including area code)      |

 

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

 

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

 

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

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

 

 

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**PART I**

**FINANCIAL INFORMATION**

**ITEM 1.  Financial Statements**

**BANCTEC, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                           | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                           | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| CURRENT ASSETS:                                                                                                                      |       |                         |       |                        |       |
| Cash and cash equivalents, including restricted cash of $7,046 and  $19,578 at September 30, 2004 and December 31, 2003    |       | $                            | 58,698     |                        | $          | 61,566 |   |
| Accounts receivable, less allowance for doubtful accounts of  $972 and $1,126 at September 30,  2004 and December 31, 2003 |       | 44,558                       |       | 39,193                      |       |
| Inventories, net                                                                                                                     |       | 22,623                       |       | 23,908                      |       |
| Prepaid expenses                                                                                                                     |       | 6,324                        |       | 4,823                       |       |
| Other current assets                                                                                                                 |       | 42                           |       | 21                          |       |
| Total current assets                                                                                                                 |       | 132,245                      |       | 129,511                     |       |
|                                                                                                                                 |       |                         |       |                        |       |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                                                   |       | 37,096                       |       | 44,832                      |       |
|                                                                                                                                 |       |                         |       |                        |       |
| OTHER ASSETS:                                                                                                                        |       |                         |       |                        |       |
| Goodwill                                                                                                                             |       | 41,476                       |       | 41,476                      |       |
| Deferred income tax benefit                                                                                                          |       | 12,891                       |       | 13,796                      |       |
| Other assets                                                                                                                         |       | 5,018                        |       | 9,900                       |       |
| Total other assets                                                                                                                   |       | 59,385                       |       | 65,172                      |       |
|                                                                                                                                 |       |                         |       |                        |       |
| TOTAL ASSETS                                                                                                                         |       | $                            | 228,726    |                        | $          | 239,515 |   |
|                                                                                                                                 |       |                         |       |                        |       |
| CURRENT LIABILITIES:                                                                                                                 |       |                         |       |                        |       |
| Current obligations under capital leases                                                                                             |       | $                            | 567        |                        | $          | 1,105 |   |
| Trade accounts payable                                                                                                               |       | 12,085                       |       | 13,122                      |       |
| Other accrued expenses and liabilities                                                                                               |       | 47,078                       |       | 36,901                      |       |
| Deferred revenue                                                                                                                     |       | 14,570                       |       | 22,179                      |       |
| Maintenance contract deposits                                                                                                        |       | 44,797                       |       | 44,540                      |       |
| Income taxes                                                                                                                         |       | 1,832                        |       | 1,717                       |       |
| Total current liabilities                                                                                                            |       | 120,929                      |       | 119,564                     |       |
|                                                                                                                                 |       |                         |       |                        |       |
| OTHER LIABILITIES:                                                                                                                   |       |                         |       |                        |       |
| Long-term debt, less current maturities                                                                                              |       | 197,823                      |       | 197,823                     |       |
| Non-current maintenance contract deposits                                                                                            |       | 24,175                       |       | 30,837                      |       |
| Other noncurrent liabilities                                                                                                         |       | 16,863                       |       | 16,750                      |       |
| Total other liabilities                                                                                                              |       | 238,861                      |       | 245,410                     |       |
|                                                                                                                                 |       |                         |       |                        |       |
| Total liabilities                                                                                                                    |       | 359,790                      |       | 364,974                     |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                        |       |                         |       |                        |       |
|                                                                                                                                 |       |                         |       |                        |       |
| SERIES A PREFERRED STOCK (Note 3)                                                                                                    |       | —                       |       | 16,568                      |       |
| SERIES B PREFERRED STOCK (Note 3)                                                                                                    |       | —                       |       | 10,609                      |       |
|                                                                                                                                 |       |                         |       |                        |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                          |       |                         |       |                        |       |
| Cumulative preferred stock - authorized, 1,000,000 shares of $0.01  par value at September 30, 2004 and December 31, 2003  |       |                         |       |                        |       |
| Series A preferred stock - issued and outstanding,  100,667 shares at September 30, 2004 and December 31,  2003       |       | 17,919                       |       | —                      |       |
| Series B preferred stock - issued and outstanding,  35,520 shares at September 30, 2004 and December 31,  2003        |       | 12,718                       |       | —                      |       |
| Common stock authorized, 22,000,000 shares of $0.01 par value at  September 30, 2004 and December 31,  2003:               |       |                         |       |                        |       |
| Common stock-issued and outstanding  17,003,838 shares at September 30, 2004  and December 31, 2003                   |       | 170                          |       | 170                         |       |
| Class A common stock-issued and outstanding 1,181,946 shares  at September 30, 2004 and December 31,  2003                 |       | 12                           |       | 12                          |       |
| Subscription stock warrants                                                                                                          |       | 3,726                        |       | 3,726                       |       |
| Additional paid-in capital                                                                                                           |       | 123,578                      |       | 127,038                     |       |
| Accumulated deficit                                                                                                                  |       | (274,940                     | )          | (269,020                    | )          |
| Accumulated other comprehensive loss                                                                                                 |       | (14,247                      | )          | (14,562                     | )          |
| Total stockholders’ deficit                                                                                                     |       | (131,064                     | )          | (152,636                    | )          |
|                                                                                                                                 |       |                         |       |                        |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                     |       | $                            | 228,726    |                        | $          | 239,515 |   |

 

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,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                          | ** ** | **(In  thousands)**                        | ** ** | **(In  thousands)**                       | ** ** |
| REVENUE                                             |       |                                       |       |                                      |       |   |   |   |   |
| Equipment and software                              |       | $                                          | 27,364     |                                      | $          | 37,260 |   | $ | 101,950 |   | $ | 110,258 |   |
| Maintenance and other services                      |       | 55,753                                     |       | 60,143                                    |       | 170,070 |   | 174,940 |   |
|                                                |       | 83,117                                     |       | 97,403                                    |       | 272,020 |   | 285,198 |   |
| COST OF SALES                                       |       |                                       |       |                                      |       |   |   |   |   |
| Equipment and software                              |       | 18,912                                     |       | 23,795                                    |       | 66,345 |   | 72,510 |   |
| Maintenance and other services                      |       | 48,042                                     |       | 49,568                                    |       | 145,792 |   | 141,277 |   |
|                                                |       | 66,954                                     |       | 73,363                                    |       | 212,137 |   | 213,787 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| Gross profit                                        |       | 16,163                                     |       | 24,040                                    |       | 59,883 |   | 71,411 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| OPERATING EXPENSES                                  |       |                                       |       |                                      |       |   |   |   |   |
| Product development                                 |       | 1,833                                      |       | 3,027                                     |       | 6,396 |   | 10,419 |   |
| Selling, general and administrative                 |       | 13,365                                     |       | 11,281                                    |       | 40,818 |   | 41,453 |   |
|                                                |       | 15,198                                     |       | 14,308                                    |       | 47,214 |   | 51,872 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| Income from operations                              |       | 965                                        |       | 9,732                                     |       | 12,669 |   | 19,539 |   |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                             |       |                                       |       |                                      |       |   |   |   |   |
| Interest income                                     |       | 193                                        |       | 138                                       |       | 484 |   | 547 |   |
| Interest expense                                    |       | (4,782                                     | )          | (4,945                                    | )          | (14,336 | ) | (14,613 | ) |
| Sundry, net                                         |       | 503                                        |       | 173                                       |       | (1,489 | ) | 1,571 |   |
|                                                |       | (4,086                                     | )          | (4,634                                    | )          | (15,341 | ) | (12,495 | ) |
|                                                |       |                                       |       |                                      |       |   |   |   |   |
| INCOME (LOSS) BEFORE INCOME TAXES                   |       | (3,121                                     | )          | 5,098                                     |       | (2,672 | ) | 7,044 |   |
| INCOME TAX EXPENSE                                  |       | 328                                        |       | 881                                       |       | 3,248 |   | 2,670 |   |
| NET INCOME (LOSS)                                   |       | (3,449                                     | )          | 4,217                                     |       | (5,920 | ) | 4,374 |   |
| PREFERRED STOCK DIVIDENDS AND ACCRETION OF DISCOUNT |       | (1,215                                     | )          | (1,025                                    | )          | (3,460 | ) | (2,927 | ) |
| NET INCOME (LOSS) APPLICABLE TO COMMON STOCK        |       | $                                          | (4,664     | )                                         | $          | 3,192 |   | $ | (9,380 | ) | $ | 1,447 |   |

 

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,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| ** **                                                                      | ** ** | **(In  thousands)**                       | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES                                            |       |                                      |       |   |   |
| Net income                                                                      |       | $                                         | (5,920     | ) | $ | 4,374 |   |
| Adjustments to reconcile to cash flows provided by operations:                  |       |                                      |       |   |   |
| Depreciation and amortization                                                   |       | 12,461                                    |       | 14,348 |   |
| Provision for doubtful accounts                                                 |       | (159                                      | )          | (486 | ) |
| Deferred income tax expense                                                     |       | 905                                       |       | — |   |
| Loss on disposition of property, plant and equipment                            |       | 535                                       |       | 536 |   |
| Gain on extinguishment of long-term debt                                        |       | —                                    |       | (1,129 | ) |
| Other non-cash items                                                            |       | 304                                       |       | 42 |   |
| Changes in operating assets and liabilities                                     |       |                                      |       |   |   |
| (Increase) decrease in accounts receivable                                      |       | (5,206                                    | )          | 10,706 |   |
| (Increase) decrease in inventories                                              |       | 1,200                                     |       | (4,493 | ) |
| (Increase) decrease in other assets                                             |       | 455                                       |       | 632 |   |
| Increase (decrease) in trade accounts payable                                   |       | (1,037                                    | )          | 2,651 |   |
| Increase (decrease) in deferred revenue & maintenance contracts  deposits   |       | (6,696                                    | )          | 7,800 |   |
| Increase in other accrued expenses and liabilities                              |       | 3,118                                     |       | (3,648 | ) |
| Cash flows provided by (used in) operating activities                           |       | (40                                       | )          | 31,333 |   |
|                                                                            |       |                                      |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                            |       |                                      |       |   |   |
| Purchases of property, plant and equipment                                      |       | (5,421                                    | )          | (4,656 | ) |
| 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                                         |       | (2,169                                    | )          | (4,656 | ) |
|                                                                            |       |                                      |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                            |       |                                      |       |   |   |
| Payments of current maturities of long-term debt and capital lease  obligations |       | (865                                      | )          | (858 | ) |
| Payments on long-term borrowing                                                 |       | —                                    |       | (2,752 | ) |
| Debt issuance costs                                                             |       | (50                                       | )          | (95 | ) |
| Cash flows used in financing activities                                         |       | (915                                      | )          | (3,705 | ) |
|                                                                            |       |                                      |       |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                         |       | 256                                       |       | 395 |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                       |       | (2,868                                    | )          | 23,367 |   |
| CASH AND CASH EQUIVALENTS-BEGINNING OF YEAR                                     |       | 61,566                                    |       | 31,595 |   |
|                                                                            |       |                                      |       |   |   |
| CASH AND CASH EQUIVALENTS-END OF PERIOD                                         |       | $                                         | 58,698     |   | $ | 54,962 |   |
|                                                                            |       |                                      |       |   |   |
| SUPPLEMENTAL DISCLOSURES INFORMATION:                                           |       |                                      |       |   |   |
| Cash paid (refunded) during the period for:                                     |       |                                      |       |   |   |
| Interest                                                                        |       | $                                         | 11,574     |   | $ | 13,588 |   |
| Taxes                                                                           |       | $                                         | 2,196      |   | $ | (160 | ) |

 

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

 

The accompanying unaudited condensedconsolidated balance sheet at September 30, 2004, and the unauditedcondensed consolidated statements ofoperations and cash flows for the interim periods ended September 30, 2004and 2003, should be read in conjunction with BancTec, Inc. and subsidiaries (“BancTec”or the “Company”) consolidated financial statements and notes thereto in themost recent Annual Report on Form 10-K filed with the Securities and ExchangeCommission.   In the opinion ofmanagement, the accompanying condensedconsolidated financial statements contain all material adjustments, consistingprincipally of normal recurring adjustments, necessary for a fair presentationof the financial position and results of operations of the Company. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

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

 

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

 

**Cash and Cash Equivalents 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 30,2004, of $7.0 million represents the cash pledged under the terms of theRevolver.

 

**Allowance for Doubtful Accounts**

 

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

 

**Inventories**

 

Inventories are valued at the lower of costor market and include the cost of replacement parts, raw materials, labor,factory overhead, and purchased subassemblies. Cost is determined using thefirst-in, first-out and weighted average methods. At least quarterly, theCompany evaluates the carrying amount of inventory based on the identificationof excess and obsolete inventory. The Company’s evaluation involves amulti-element approach incorporating the stratification of inventory by timeheld and the stratification of inventory by risk category, among otherelements.  The approach incorporates bothrecent historical information and management estimates of trends. The Company’sapproach is intended to take into consideration potential excess andobsolescence caused by a decreasing installed base, engineering changes and endof manufacture.  If any of the elementsof the Company’s estimate were to deteriorate, write-downs may be required. Theinventory write-down calculations are reviewed periodically and additionalwrite-downs are recorded as deemed necessary. Inventory reserves as of September 30, 2004, and December 31,2003, were $14.0 million and $15.0 million respectively.  Inventoryreserves establish a new cost basis for inventory and are not reversed infuture periods.

 

**Property, Plant, and Equipment**

 

Property, plant, and equipment are recordedat cost and are depreciated or amortized principally on a straight-line basisover the estimated useful lives of the related assets. Estimated useful livesrange from three to five years for field support spare parts, three to eightyears for systems and software, five to seven years for machinery andequipment, leasehold improvements, and furniture and fixtures. Buildings aredepreciated over 40 years.   Depreciationexpense for the nine months ended September 30, 2004 and 2003 was $12.5million and $14.3 million respectively.

 

5

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**Revenue Recognition**

 

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

 

The Company applies the provisions of Statement of Position 97-2, “SoftwareRevenue Recognition,” as amended by Statement of Position 98-9 “Modificationof SOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions” to all transactions involving the sale of software products andsales of hardware where the software is not incidental. For those transactionsthat involve acceptance certificates, the Company recognizes revenue uponreceipt of the acceptance certificate, or when it can be objectivelydemonstrated that acceptance criteria have been met.  For hardware transactions where software isconsidered incidental, or no software is included, revenue is recognized whenthe product has been delivered and all obligations have been fulfilled.

 

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

 

The Company recognizes hardware and software revenue when persuasiveevidence of an arrangement exists, delivery has occurred, the sales price isfixed or determinable and collectibility is probable. At the time of thetransaction, the Company determines whether the fee associated with revenuetransactions is fixed or determinable and whether or not collection isreasonably assured. The Company determines whether the fee is fixed ordeterminable based on the payment terms associated with the transaction. If asignificant portion of a fee is due after the normal payment terms, which aregenerally 30 days from invoice date, the Company recognizes revenue as the feesare collected. The Company assesses collectibility based on a number offactors, including past transaction history with the customer and thecredit-worthiness of the customer. The Company does not request collateral fromcustomers. If the Company determines that collection of the fee is notreasonably assured, the Company defers the revenue and recognizes revenue atthe time collection becomes reasonably assured, which is generally upon receiptof cash. For all sales, the Company generally uses either a binding purchaseorder or signed sales agreement as evidence of an arrangement.

 

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

 

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

 

**Research and Development**

 

Research and development costs are expensedas incurred.   Research and developmentcosts for the nine months ended September 30, 2004, and 2003, were $6.4million and $10.4 million respectively.

 

**Income Taxes**

 

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

 

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

 

6

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

 

**Stock-Based Compensation**

 

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

 

2000 Stock Plan:

 

Effective July 1, 2000, the 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 31,2003, the Company granted 45,000 incentive options.  During the nine months ended September 30,2004, 1,379,550 incentive options were granted. Under the Plan, incentive options are granted at a fixed exercise pricenot less than 100% of the fair market value of the shares of stock on the dateof grant (or 110% of the fair market value in certain circumstances). A portionof the incentive options vest over a four-year period at 25% per year beginningJanuary 2, 2001; the remainder vest based on the performance of theCompany. As a part of an employee retention program, vesting of 20.0% of theperformance-based incentive options was accelerated in October 2000.

 

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

 
| ** **                                       | ** ** | **Incentive  Shares** | ** ** | **Non-qualified  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|---------------------------|------------|----------------------------------------|------------|
| Options outstanding–December 31, 2002  |       | 497,240               |       | 31,760                    |       | 9.25                                   |       |
| Granted                                          |       | 45,000                |       | —                    |       | 9.25                                   |       |
| Forfeited                                        |       | (60,000               | )          | —                    |       | 9.25                                   |       |
|                                             |       |                  |       |                      |       |                                   |       |
| Options outstanding–December 31, 2003  |       | 482,240               |       | 31,760                    |       | 9.25                                   |       |
| Granted                                          |       | 1,379,550             |       | 50,000                    |       | 9.25                                   |       |
| Forfeited                                        |       | (121,500              | )          | (50,000                   | )          | 9.25                                   |       |
|                                             |       |                  |       |                      |       |                                   |       |
| Options outstanding–September 30, 2004 |       | 1,740,290             |       | 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, 2004, options topurchase 1,772,050 shares were outstanding, of which 226,500 were vested.  All options outstanding have an exerciseprice of $9.25.  No options have beenexercised.

 

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

 

7

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

 
| ** **                                                                                                             | ** ** | **Nine  Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| Net income (loss) as reported                                                                                          |       | $                                         | (5,920     | ) | $ | 4,374 |   |
| Total  stock-based employee compensation expense determined under fair-value-based  method for all rewards, net of tax |       | (42                                       | )          | 12 |   |
|                                                                                                                   |       |                                      |       |   |   |
| Pro Forma net income (loss)                                                                                            |       | $                                         | (5,962     | ) | $ | 4,386 |   |

 

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

 

## *Reclassification*

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

 

The Company has two issues of Preferred Stockas described in Note 14 – Preferred Stock, contained in Notes to the CondensedConsolidated Financial Statements.  SeriesA Preferred Stock has been historically classified in the mezzanine section ofthe Consolidated Balance Sheets due to the provision providing for mandatoryredemption.  On March 31,2004, the Board of Directors and the holder of the Series A Preferred Stockapproved an amendment to the Series A Preferred Stock agreement to remove themandatory redemption provision.

 

Both the Series A Preferred and the Series BPreferred include provisions for redemption at the option of holders in certaincircumstances including a sale or merger of the Company and redemption at theoption of the Company.  At December 31,2003, the Series B Preferred was classified in the mezzanine section asprovided by guidance contained in EITF Topic D-98, “Classificationand Measurement of Redeemable Securities.” Under this guidance, classification in the permanent equity section isnot considered appropriate if the preferred stock is redeemable upon majorityvote of the Board of Directors and such board is controlled by the preferredsecurity holders.  At December 31,2003, preferred security holders comprised 50% of the Board of Directors.  On March 31, 2004, the Board ofDirectors elected a seventh member who is not a preferred security holder.  As a result of the removal of the mandatoryredemption provisions for Series A Preferred Stock and the addition of theseventh board member whereby the preferred security holders no longer controlthe Board of Directors, the Series A and Series B Preferred Stock are beingreclassified into the permanent equity section of the Consolidated BalanceSheets at September 30, 2004.

 

*Impairment*

The Company’s investments in non-marketable equity securities ismonitored for impairment and is written down to fair value with a change toearnings if a decline in fair value is judged to be other than temporary.  During the second quarter of 2004, theCompany recorded a write down of approximately $1.5 million to reflect theestimated fair value of $2.7 million in its investment in the stock ofServibanca S.A. (43.4% interest), which is accounted for as an equityinvestment.  The sale of this stock, at anet sales price of $2.7 million was completed in August 2004.  The impairment charge of $1.5 million isreflected in Sundry, net in the Condensed Consolidated Statements of Operationsfor the nine months ended September 30, 2004.

 

**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,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| ** **                                                        | ** ** | **(In thousands)**                  | ** ** |
| Capital  lease obligation incurred for lease of computer hardware |       | $                                   | 241        |   | $ | 2,049 |   |
| Inventory  put in service as fixed asset                          |       | 105                                 |       | 1,857 |   |
|                                                                   |            |                                     |            |  |  |  |  |

 

8

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**5.****                                      INVENTORIES**

 

Inventory consists of the following: 

 
| ** **                            | ** ** | **September 30,    2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **(In  thousands)**            | ** ** |
| Raw materials & replacement parts |       | $                              | 9,792      |                        | $          | 6,035 |   |
| Work-in-progress                      |       | 5,395                          |       | 7,168                       |       |
| Finished goods                        |       | 7,436                          |       | 10,705                      |       |
|                                  |       |                           |       |                        |       |
|                                  |       | $                              | 22,623     |                        | $          | 23,908 |   |

 

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

 

Property, plant and equipment consist of thefollowing:

 
| ** **                                | ** ** | **September 30,    2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(In  thousands)**            | ** ** |
| Land                                      |       | $                              | 2,860      |                        | $          | 2,860 |   |
| Field support spare parts                 |       | 59,163                         |       | 59,789                      |       |
| Systems and software                      |       | 60,139                         |       | 58,927                      |       |
| Machinery and equipment                   |       | 21,000                         |       | 21,075                      |       |
| Furniture, fixtures and other             |       | 19,211                         |       | 19,514                      |       |
| Buildings                                 |       | 27,727                         |       | 27,653                      |       |
|                                      |       |                           |       |                        |       |
|                                      |       | 190,100                        |       | 189,818                     |       |
| Accumulated depreciation and amortization |       | 153,004                        |       | 144,986                     |       |
|                                      |       |                           |       |                        |       |
| Property, plant and equipment, net        |       | $                              | 37,096     |                        | $          | 44,832 |   |

 

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

 

Other accrued expenses and liabilitiesconsist of the following:

 
| ** **                             | ** ** | **September 30,    2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **(In  thousands)**            | ** ** |
| Salaries, wages and other compensation |       | $                              | 12,480     |                        | $          | 12,843 |   |
| Accrued taxes, other than income taxes |       | 5,000                          |       | 5,312                       |       |
| Advances from customers                |       | 8,225                          |       | 907                         |       |
| Accrued interest payable               |       | 4,963                          |       | 3,211                       |       |
| Accrued invoices and costs             |       | 1,537                          |       | 2,114                       |       |
| Other                                  |       | 14,873                         |       | 12,514                      |       |
|                                   |       |                           |       |                        |       |
|                                   |       | $                              | 47,078     |                        | $          | 36,901 |   |

 

9

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

 

Debt and other obligations consist of thefollowing:

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

 

Revolving Credit Facility.  TheCompany has a revolving credit facility (the “Revolver”) provided by HellerFinancial, Inc. (“Heller”), which matures on May 30, 2006.  Effective May 7, 2003, the Company andHeller entered into an amendment to the Revolver which reduced the committedamount from $60 million to $40 million, while increasing the letter-of-creditsub-limit from $30 million to $40 million. The Revolver is secured by substantially all the assets of the Company,subject to the limitations on liens contained in the Company’s existing SeniorNotes.   Funds availability under theRevolver is determined by a borrowing-base formula equal to a specifiedpercentage of the value of the Company’s eligible accounts receivable,inventory and pledged cash.  At September 30,2004, the Company had no balance outstanding under the Revolver and anoutstanding balance on letters-of-credit totaling $7.0 million.  The balance remaining under the Revolver thatthe Company can draw was $16.1 million at September 30, 2004 ($20.1million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Under an amendment 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) 2.0 to 1.0, (2)1.75 to 1.0, (3) 1.5 to 1.0 and (4) 1.25 to 1.0 and (total rate increase of1.00%) or decreased by 0.25% increments when the fixed charge coverage ratio isgreater than 2.25 to 1.0 (total rate decrease of 0.25%).  At September 30, 2004, the Company’srate on the Revolver was 5.75%.

 

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, 2004 of $7.0 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.  At September 30,2004, the Company was in compliance with all covenants under the Revolver.

 

Senior Notes.  Interest on the Senior Notes is fixed at 7.5%and is due and payable 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. Duringthe first six months of 2003, the Company repurchased Senior Notes with a faceamount of $3.9 million. The Company wrote off a proportionate share of deferredfinancing-fees, resulting in a gain of approximately $1.1 million, which wasreported as sundry (other) income in the condensed consolidatedstatements of operations for the interim period ended June 30, 2003.  Theestimated fair value of the Senior Notes as of September 30, 2004, isapproximately $66.9 million based on an average value of the most recentlycompleted market trades, resulting in a yield-to-maturity of approximately21%.  The number of actual trades islimited; therefore the result may vary if a widely traded market environmentexisted.

 

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.  

 

10

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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.  A holder ofthe Senior Notes has sought to contest this payment.  See discussion under Legal Proceedings.  The estimated fair-value of the Sponsor Noteand deferred interest and fees as of September 30, 2004, is approximately$60.2 million assuming a yield-to-maturity of 26%.

 

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

 

Capital Leases.  During the first quarter of 2003, the Companyentered into a capital lease for $2.0 million that pertained to computerhardware.  Amounts due under capitalleases are recorded as liabilities. The Company’s interest in assets acquiredunder capital leases is recorded as property and equipment on the CondensedConsolidated Balance Sheets. Amortization of assets recorded under capitalleases is included in depreciation expense. The current portion of obligations under capital leases are classifiedin the current liabilities section of the Condensed Consolidated BalanceSheets and the non-current portion of capital leases are included in OtherLiabilities.

 

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

 

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

 

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

 

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

 

11

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**10.****                               TAXES**

 

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

 
| ** **                                     | ** ** | **September 30,    2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **(In thousands)**             | ** ** |
| Gross deferred tax assets:                     |       |                           |       |                        |       |
| Net operating losses                           |       | $                              | 41,300     |                        | $          | 38,106 |   |
| AMT credit carryforwards                       |       | 102                            |       | 328                         |       |
| Inventory reserves                             |       | 5,036                          |       | 5,360                       |       |
| Receivable allowance                           |       | 196                            |       | 301                         |       |
| Intangible assets previously deducted          |       | 1,014                          |       | 1,341                       |       |
| Deferred revenues                              |       | 15,750                         |       | 23,152                      |       |
| Deferred compensation                          |       | 3,688                          |       | 2,443                       |       |
| Foreign timing differences, net                |       | 3,543                          |       | 3,835                       |       |
| Taxes paid on intercompany profits             |       | 1,137                          |       | 938                         |       |
| Other                                          |       | 4,416                          |       | 5,129                       |       |
|                                           |       |                           |       |                        |       |
| Total gross deferred tax asset                 |       | 76,182                         |       | 80,933                      |       |
|                                           |       |                           |       |                        |       |
| Gross deferred tax liabilities:                |       |                           |       |                        |       |
| Depreciation                                   |       | (1,235                         | )          | (1,646                      | )          |
| Undistributed earnings of foreign subsidiaries |       | (5,837                         | )          | —                      |       |
| Other                                          |       | —                         |       | (679                        | )          |
|                                           |       |                           |       |                        |       |
| Total gross deferred tax liability             |       | (7,072                         | )          | (2,325                      | )          |
| Deferred tax asset valuation reserve           |       | (56,219                        | )          | (64,812                     | )          |
|                                           |       |                           |       |                        |       |
| Net deferred tax asset                         |       | $                              | 12,891     |                        | $          | 13,796 |   |

 

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.  Thevaluation allowance for deferred tax assets as of September 30, 2004 and December 31,2003 was $56,219,000 and $64,812,000, respectively.  The net change in the total valuationallowance for the nine months ended September 30, 2004 was a decrease of$8,593,000, consisting of a $5,837,000 decrease related to the recording of adeferred tax liability on the undistributed earnings of two foreignsubsidiaries, a decrease of $2,039,000 related to the true up to the 2003Income Tax Return and a decrease of $717,000 related to continuing operations.

 

Undistributed earnings of foreignsubsidiaries included in continuing operations were approximately $26.4 and$35.9 million at September 30, 2004 and December 31, 2003,respectively. Taxes have been provided on the undistributed earnings of twosubsidiaries, BancTec Limited and BancTec Holding N.V., as specified by APB 23,“Accounting for Income Taxes—Special Areas,” due to the distribution ofdividends from these subsidiaries during the nine months ended September 302004.  No taxes have been provided forthe other subsidiaries as they are considered to be permanently reinvested.

 

**11.****                               WARRANTYLIABILITY**

 

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.

 

12

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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 30,2004 are summarized as follows:

 
| ** **                                        | ** ** | **(In  thousands)** | ** ** |
|---------------------------------------------------|------------|---------------------|------------|
| Balance at December 31,  2003                |       | $                   | 140        |   |
| Warranties  issued                                |       | 90                  |       |
| Claims  paid/settlements                          |       | (67                 | )          |
| Changes in  liability for pre-existing warranties |       | 17                  |       |
|                                              |       |                |       |
| Balance at September 30,  2004               |       | $                   | 180        |   |

 

**12.****                               COMPREHENSIVELOSS**

 

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

 
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **(In thousands)**                         | ** ** | **(In thousands)**                        | ** ** |
| Net income  (loss)                        |       | $                                          | (3,449     | )                                         | $          | 4,217 |   | $ | (5,920 | ) | $ | 4,374 |   |
| Foreign  currency translation adjustments |       | 3                                          |       | 132                                       |       | 315 |   | 769 |   |
|                                      |       |                                       |       |                                      |       |   |   |   |   |
| Total  comprehensive income (loss)        |       | $                                          | (3,446     | )                                         | $          | 4,349 |   | $ | (5,605 | ) | $ | 5,143 |   |

 

13

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

 

The Company segments its operations based ongeographical areas  (U.S.Solutions (“USS”) and International Solutions (“INTL”)) and product lines (Computer andNetwork Services (“CNS”)). INTL offers similar products as USS and consistsprimarily of operations throughout the world excluding the United States.

 
| ** **                                         | ** ** | **US   Solutions**  | ** ** | **Computer  & Network  Services** | ** ** | **International** | ** ** | **Corp/Elims** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|-------------------|------------|----------------|------------|-----------|------------|
| ** **                                         | ** ** | **(In  thousands)** | ** ** |
| For the three months ended September 30, 2004 |       |                |       |                                  |       |              |       |           |       |      |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| Revenue from external customers                    |       | $                   | 24,287     |                                  | $          | 32,363            |       | $              | 26,467     |      | $          | — |   | $ | 83,117 |   |
| Intersegment revenue                               |       | 759                 |       | —                                |       | 2,500             |       | (3,259         | )          | —    |       |
| Segment gross profits                              |       | 5,620               |       | 2,200                                 |       | 8,609             |       | (266           | )          | 16,163    |       |
| Segment operating income (loss)                    |       | 1,124               |       | 296                                   |       | 1,484             |       | (1,939         | )          | 965       |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| For the three months ended September 30, 2003 |       |                |       |                                  |       |              |       |           |       |      |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| Revenue from external customers                    |       | $                   | 34,803     |                                  | $          | 34,889            |       | $              | 27,711     |      | $          | — |   | $ | 97,403 |   |
| Intersegment revenue                               |       | 568                 |       | —                                |       | 1,965             |       | (2,533         | )          | —    |       |
| Segment gross profits                              |       | 8,815               |       | 5,126                                 |       | 10,380            |       | (281           | )          | 24,040    |       |
| Segment operating income (loss)                    |       | 3,107               |       | 3,065                                 |       | 4,962             |       | (1,402         | )          | 9,732     |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| For the nine months ended September 30, 2004  |       |                |       |                                  |       |              |       |           |       |      |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| Revenue from external customers                    |       | $                   | 84,437     |                                  | $          | 97,714            |       | $              | 89,869     |      | $          | — |   | $ | 272,020 |   |
| Intersegment revenue                               |       | 2,231               |       | —                                |       | 6,463             |       | (8,694         | )          | —    |       |
| Segment gross profits                              |       | 19,450              |       | 9,068                                 |       | 31,875            |       | (510           | )          | 59,883    |       |
| Segment operating income (loss)                    |       | 4,620               |       | 3,030                                 |       | 10,931            |       | (5,912         | )          | 12,669    |       |
| Segment identifiable assets                        |       | 76,839              |       | 25,492                                |       | 50,966            |       | 75,429         |       | 228,726   |       |
| Capital appropriations                             |       | 1,509               |       | 1,797                                 |       | 1,297             |       | 1,164          |       | 5,767     |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| For the nine months ended September 30, 2003  |       |                |       |                                  |       |              |       |           |       |      |       |
|                                               |       |                |       |                                  |       |              |       |           |       |      |       |
| Revenue from external customers                    |       | $                   | 105,417    |                                  | $          | 98,656            |       | $              | 81,125     |      | $          | — |   | $ | 285,198 |   |
| Intersegment revenue                               |       | 1,674               |       | —                                |       | 5,035             |       | (6,709         | )          | —    |       |
| Segment gross profits                              |       | 24,512              |       | 17,988                                |       | 28,917            |       | (6             | )          | 71,411    |       |
| Segment operating income (loss)                    |       | 5,732               |       | 11,542                                |       | 9,323             |       | (7,058         | )          | 19,539    |       |
| Segment identifiable assets                        |       | 94,821              |       | 27,824                                |       | 54,025            |       | 64,354         |       | 241,024   |       |
| Capital appropriations                             |       | 1,820               |       | 1,082                                 |       | 3,138             |       | 2,522          |       | 8,562     |       |

 

**14.****                               PREFERRED STOCK**

 

**SERIES A PREFERRED STOCK**

 

The Company allocated the proceeds from itsSeries A preferred stock issuance based upon the relative fair value of thepreferred stock and warrants issued.  Therelated discount is being accreted over a period of eight years.  For the nine months ended September 30,2004, accretion of the related discount andaccrued but unpaid dividends totaled $1.4 million, increasing the carryingamount to $17.9 million. As of September 30, 2004, the stated value of the Series A preferredstock, including accumulated but unpaid dividends, was $197.83 per share.

 

**SERIES B PREFERRED STOCK**

 

For the nine months ended September 30,2004, the Company accrued additional unpaiddividends for its Series B preferred stock totaling $2.1 million, increasingthe carrying amount to $12.7 million.  Asof September 30, 2004, thestated value of the Series B preferred stock, including accumulated but unpaiddividends, was $358.05 per share.

 

14

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

 

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

 

**16.          SUBSEQUENT EVENTS**

 

None

 

15

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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 Form10-Q, including Management’s Discussion and Analysis of Financial Condition andResults of Operations and Quantitative and Qualitative Disclosure About MarketRisk, contains forward-looking statements as that term is defined in thePrivate Securities Litigation Reform Act of 1995 (the “PSLRA”) that involverisks and uncertainties, as well as assumptions that, if they never materializeor prove incorrect, could cause the results of BancTec, Inc. and itsconsolidated subsidiaries (the “Company”) to differ materially from thoseexpressed or implied by such forward-looking statements. All statements otherthan statements of historical fact could be deemed forward-looking statements,including any projections of earnings, revenues, or other financial items; anystatements of the plans, strategies, and objectives of management for futureoperations; any statements concerning proposed new products, services, ordevelopments; any statements regarding future economic conditions orperformance; statements of belief and any statement of assumptions underlyingany of the foregoing. The risks, uncertainties and assumptions referred toabove include technological improvements that reduce the market forpaper-handling products, the ability of the Company to retain and motivate keyemployees; the timely development, production and acceptance of products andservices and their feature sets; the challenge of managing asset levels,including inventory; the flow of products into third-party distributionchannels; the difficulty of keeping expense growth at modest levels whileincreasing revenues; and other risks that are described from time to time inthe Company’s Securities and Exchange Commission reports, including but notlimited to the items discussed in “Factors Affecting the Company’s Business andProspects” set forth in this report, and items described in the Company’s otherfilings with the Securities and Exchange Commission. The Company undertakes noobligation to update or revise forward-looking statements to reflect changes inassumptions, the occurrence of unanticipated results or changes to futureoperating results over time.*

 

**Overview**

 

The Company believes severalfactors continued to create a challenging and competitive sales andcost-containment environment during the nine months ended September 30,2004.  These factors include: the impactof check truncation, reduced corporate customer technology spending; ongoingcompetitive pressures; an ongoing planned change in revenue mix within theCompany’s U.S. Solutions (“USS”) and International Solutions (“INTL”) segments;and a highly leveraged financial position. The change in revenue mix is partially a result of trends in paymentprocessing, including truncation, which impacts domestic and internationalmarkets.  Additionally, during the ninemonths ended September 30, 2004, the USS and INTL segments experiencedrevenue declines in the maintenance business, the duration of which the Companycannot predict.

 

Computer and Network Services (“CNS”)encounters aggressive competition from a variety of companies.  The Company believes that functionality,performance, quality, service, and price are important competitive factors inthe markets in which it operates.  Whilethe Company believes that its offerings compete favorably based on each ofthese elements, the Company could be adversely affected if its competitorsoffer their products at significantly lower prices than the Company.

 

Expected economic and businessconditions into the remainder of 2004 indicate a cautious outlook regarding theCompany’s near-term revenue and earnings growth prospects.  The passage of the Check Clearing for the 21stCentury Act (“Check 21”), to allow for the truncation of checks, is expected toresult in decreased demand for payment and check clearing solutions.  The Company has concentrated on costreductions and on document processing solutions.  Product-development efforts are being focusedon document processing technologies, including Electronic Document Management (“EDM”)vertical solutions and high-speed, full-page scanners, as well as continuedhardware enhancements. By incorporating more third-party products into theCompany’s solutions rather than developing the products, the Company can moreeasily target its efforts and expenditures to these core products andsolutions.

 

**RESULTS OF OPERATIONS**

 

**Comparison of Three MonthsEnded September 30, 2004 and Three Months Ended September 30, 2003**

 

Consolidated revenue of $83.1 million for thethree months ended September 30, 2004 was a decrease of $14.3 million or14.7% from the comparable prior-year period. The USS revenue decrease of $10.5 million was partially related to adecline in maintenance revenue due to the Company’s installed products reachingthe end of their useful lives and from increased competition.  The Company expects these trends to continuein the foreseeable future.  In addition,a decline in revenue related to the sale and installation of hardware andsoftware products was primarily related to a weak market for payments solutionsdue to market trends, including reduced check volume, check truncation, and therecent passage of Check 21.  Decreases inINTL of $1.2 million are the result of reduced deliveries of solutions tocustomers partially offset by the impact of the weakening dollar on theconversion of revenue stated in foreign currencies and the continued growth ofdocument processing services in the United Kingdom.  The CNS decrease of $2.5 

 

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million with the comparable prior-year periodprimarily resulted from pricing decreases, domestic competitive pressure, anddecreased volume under certain maintenance programs.  These decreases were somewhat offset by theexpansion by CNS of operations in Europe.

 

Factors expected to impact future revenueinclude corporate-customer spending for large systems-solutions, the continuedimpacts of check truncation, customer and prospective customer mergers,on-going competitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $16.2 milliondecreased by $7.8 million or 32.5% from the comparable prior-year period.Decreases were experienced in CNS of $2.9 million, USS of $3.2 million and inINTL of $1.8 million. The decrease in USS gross profit resulted primarily fromdecreased revenues.  In addition, the USSgross margin percentage decreased from 24.9% to 22.3%, resulting fromcompetitive pricing pressures.  Thedecreases in INTL gross profit resulted from decreased revenue and a lowergross profit percentage, decreasing from 35.0% to 29.7%, which were partiallyoffset by the impact of currency conversion. CNS’ gross profit percentage decreased from 14.6% to 6.8%, resultingprimarily from decreased revenue, margin reduction caused by competitivepricing pressure and losses experienced under certain service contracts.  CNS is the major component in the maintenanceand other services category on the Consolidated Statements of Operations, andtherefore is the primary contributing factor in the decreased gross profit inthe maintenance and other services category.

 

Operating expenses of $15.2 million increased$0.9 million compared to the prior-year period. Operating expenses, bycomponent, changed as follows: Product-development expenses decreased by $1.2million or 40.0% primarily due to the focused realignment of research anddevelopment expenditures against future product strategies and marketingplans.  The use of outsourcedproduct-development services also contributed to the reduction. Selling,general and administrative expenses (“SG&A”) increased by $2.1 million or18.6%.  This increasepartially resulted from additional marketing expenditures aimed at new productstrategies.  Also, the prior year periodincluded a reduction in net expenses related the receipt of certain propertytax refunds.

 

Interest expense for the threemonths ended September 30, 2004of $4.8 million decreased $0.1 million fromthe comparable prior-year period.

 

Sundry items resulted in a net gain of $0.5 million during the threemonths ended September 30, 2004.  This gain is primarily the result offoreign-exchange gains.  This iscompared to a net gain of $0.2 million recorded during the comparable prior-year period, also consisting primarily offoreign-exchange gains.

 

An income tax provision of $0.3 million for the three months ended September 30, 2004 is compared to a correspondingprior-year period income tax provision of $0.9 million.  The income tax provisions for both periodsrelated primarily to income from the Company’s international subsidiaries.  The Company’s effective tax rate wasapproximately (10.5)% for the three months ended September 30, 2004 as compared to 17.3% for thecorresponding prior-year period.

 

**Comparison of Nine Months EndedSeptember 30, 2004 and Nine Months Ended September 30, 2003**

 

Consolidated revenue of $272.0 million forthe nine months ended September 30, 2004 decreased by $13.2 million or4.6% from the comparable prior-year period. The USS revenue decrease of $21.0million 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 in the foreseeable future.  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.  Increases in INTL of $8.8 millionare the result of the impact of the weakening dollar on the conversion ofrevenue stated in foreign currencies and the continued growth in the UnitedKingdom of document processing services. A decrease in CNS of $1.0 million resulted from pricing decreases,domestic competitive pressure, and decreased volume under certain maintenanceprograms, partially offset by revenue increases resulting from the expansion byCNS of operations into Europe.  Factorsexpected to impact future revenue include corporate-customer spending for largesystems-solutions, the continued impacts of check truncation, customer andprospective customer mergers, on-going competitive pressures, and fluctuationsin international currencies.

 

Consolidated gross profit of $59.9 milliondecreased by $11.5 million or 16.1% from the comparable prior-year period.Decreases in CNS of $8.9 million and USS of $5.0 million were partially offsetby increases in INTL of $3.0 million. The decrease in USS resulted from decreased revenues as well as adecrease in the USS gross margin percentage from 22.9% to 22.5%.  Increases in INTL gross profit resultedpartially from increased revenue, including the impact of currency conversion,offset partially by a lower gross profit percentage, decreasing from 33.6% to33.1%. Continued efforts to provide proven deliverables as well as targeted newofferings, including EDM solutions, archive solutions andhardware enhancements, which, alongwith ongoing cost-containment efforts, allowed for cost reductions tostrengthen the INTL gross profit.  CNS’ gross profit percentage decreased from18.2% to 9.3%, resulting primarily from decreased revenue, marginreduction caused by competition pricing pressure and losses experienced undercertain service contracts.  CNS is themajor component in the maintenance and other services category on theConsolidated Statements of 

 

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Operations, and therefore is the primary contributing factor in thedecreased gross profit in the maintenance and other services category.

 

Operating expenses of $47.2 million decreased$4.7 million compared to the prior-year period. Operating expenses, bycomponent, changed as follows: product-development expenses decreased by $4.0million or 38.5% primarily due to the focused realignment of research anddevelopment expenditures against future product strategies and marketingplans.  The use of outsourcedproduct-development services also contributed to the reduction. SG&Adecreased by $0.7 million or 1.7% due to decreased SG&Adepreciation expense and on-going efforts to realign the cost structure.

 

Interest expense for the ninemonths ended September 30, 2004of  $14.3 million decreased $0.3 million from thecomparable prior-year period.

 

Sundry items resulted in a net loss of $1.5 million during the ninemonths ended September 30, 2004compared to a net income of $1.6 million during the comparable prior-year period. This decrease is primarily due to foreign-exchange losses of $0.3million and the $1.3 million loss on the sale of 100% of the Company’sinvestment in the stock of Servibanca S.A. during the current-year period,compared to a gain from the repurchase of Senior Notes of approximately $1.1million and foreign-exchange gains of $0.4 million in the prior-year period.

 

An income tax provision of $3.2 million for the nine months ended September 30, 2004 is compared to a correspondingprior-year period income tax provision of $2.7 million.  The income tax provision for the periodrelated primarily to income of approximately $8.7 million from the Company’sinternational subsidiaries.  The Company’seffective tax rate was approximately (121.6)% for the nine months ended September 30, 2004 as compared to 37.9% for thecorresponding prior-year period.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The Company’s workingcapital requirements are generally provided by cash and cash equivalents, fundsavailable under the Company’s revolving credit agreement, as discussed below,which matures May 30, 2006, and by internally generated funds from operations.Funds availability under the revolving credit agreement is determined by aborrowing-base formula equal to a specified percentage of the value of theCompany’s eligible accounts receivable, inventory and pledged cash.  General economic conditions, the currentweakness in demand for the Company’s systems solutions products and therequirement to obtain performance bonds or similar instruments could have animpact on the Company’s future liquidity.

 

The Company’s cash and cash equivalentstotaled $58.7 million at September 30, 2004 compared with $61.6 million at December 31,2003. Working capital increased $1.4 million during the nine months ended September 30,2004 to working capital of $11.3 millioncompared to working capital of $9.9 million at December 31, 2003.  The change in working capital included acurrent liability increase of $1.3 million from increased accrued liabilitiespartially offset by decreases in deferred revenue and maintenance contractdeposits and accounts payable, a decrease in net inventories of $1.3million, an accounts receivable increase of$5.4 million and a prepaid expense increase of $1.5 million.

 

During the nine months ended September 30,2004, the Company relied primarily on cashflows generated from operating activities to fund operations. At September 30,2004, the Company had available $20.1million of borrowing capacity under the Revolver, of which the Companycan draw $16.1 million.

 

Operating activities utilized less than $0.1million and provided $31.3 million of cash in the nine months ended September 30,2004 and 2003, respectively, a decreaseof  $31.3 million.  This decrease primarily resulted from adecrease in cash generated by changes in working capital assets and liabilitiesof $21.8 million and a net income decrease of $10.3 million from the prior-yearperiod.

 

Investing activities used net cash of $2.2million and $4.7 million in the nine months ended September 30,2004 and 2003, respectively. The use ofcash during the nine months ended September 30, 2003, consisted ofpurchases of property, plant and equipment. The uses of cash for the nine months ended September 30, 2004,consisted of purchases of property, plant and equipment of $5.4 million, offsetby cash received from the sale of the Company’s interest in Servibanca S.A. of$3.0 million.

 

Financing activities used $0.9 million and$3.7 million of net cash in the nine months ended September 30,2004 and 2003, respectively.  Both uses of cash related primarily to thereduction of the Company’s debt.

 

At September 30, 2004, the Company’s principal outstanding debtinstruments consisted of (i) no balance outstanding under the revolving creditfacility maturing May 30, 2006 (which is more fully described below), (ii)  $94.0 million of 7.5% Senior Notes due 2008,and (iii) $103.8 million of Sponsor Notes due 2009. The Company or itsaffiliates may from time to time purchase, redeem or pay deferred interest onsome of its outstanding debt or equity securities.  The Company would only make these payments incompliance with the covenants of its debt instruments.

 

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

 

**Revolving Credit Facility.**The Company has a revolving credit facility (the “Revolver”)provided by Heller Financial, Inc. (“Heller”), which matures 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 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 30,2004, the Company had no balance outstanding under the Revolver and anoutstanding balance on letters-of-credit totaling $7.0 million.  The balance remaining under the Revolver thatthe Company can draw was $16.1 million at September 30, 2004 ($20.1million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Under an amendment 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) 2.0 to 1.0, (2)1.75 to 1.0, (3) 1.5 to 1.0 and (4) 1.25 to 1.0 and (total rate increase of1.00%) or decreased by 0.25% increments when the fixed charge coverage ratio isgreater than 2.25 to 1.0 (total rate decrease of 0.25%).  At September 30, 2004, the Company’srate on the Revolver was 5.75%.

 

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, 2004 of $7.0 million representscash pledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties and covenants,including financial covenants as to maximum capital expenditures, minimumfixed-charge coverage ratio and minimum average borrowing availability.  At September 30, 2004, the Company wasin compliance with all covenants under the Revolver.

 

**Senior Notes**. In August 1998, the Company issued thepublic Senior Notes (the “Senior Notes”) for the notes sold in a May 1998 Rule144A private offering. Interest is fixed at 7.5% and is due and payable insemi-annual installments, which began December 1, 1998. The Senior 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. During the six months ended June 30,2003, the Company repurchased Senior Notes with a face amount of $3.9 million.The Company wrote off a proportionate share of deferred financing fees,resulting in a gain of approximately $1.1 million, which was reported as sundry(other) income in the condensed consolidated statements of operationsfor the six months ended June 30, 2003.

 

**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. The Sponsor Note matures on July 22, 2009.  As provided under the agreement, however, theSponsor Note holder, WCAS, elected to defer quarterly interest payments of $4.0million 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.  A holder ofSenior Notes had sought to contest this payment.  See discussion under Legal Proceedings.

 

**Preferred Stock – Series A**.****The Companyallocated the proceeds from its Series A preferred stock issuance based uponthe relative fair value of the preferred stock and warrants issued. The relateddiscount is being accreted over a period of 8 years. For the nine months ended September 30,2004, accretion of the related discount andaccrued but unpaid dividends totaled $1.4 million, increasing the carryingamount to $17.9 million. As of September 30, 2004, the stated value of the Series A preferredstock, including accumulated but unpaid dividends, was $197.83 per share.

 

**Preferred Stock – Series B**.****For the ninemonths ended September 30, 2004,the Company accrued additional unpaid dividends for its Series B preferredstock totaling $2.1 million, increasing the carrying amount to $12.7million.  As of September 30,2004, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $358.05 pershare.

 

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See Note 3 – Reclassification, contained inNotes to the Condensed Consolidated Financial Statements, for a discussion ofthe reclassification of the Series A and B Preferred Stock to the permanentequity section of the Condensed Consolidated Balance Sheets under theguidance of EITF Topic D-98, “Classification and Measurement ofRedeemable Securities.”

 

**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 30,2004:

 
| ** **                        | ** ** | **Total  Amounts** | ** ** | **Less than****1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **Over 5  Years** | ** ** |
|-----------------------------------|------------|--------------------|------------|-------------------------|------------|----------------|------------|----------------|------------|-------------------|------------|
| ** **                        | ** ** | **(In Millions)**  | ** ** |
| Long-term debt                    |       | $                  | 197.8      |                    | $          | —         |       | $              | —     |              | $          | 197.8 |   | $ | — |   |
| Capital leases                    |       | 0.8                |       | 0.6                     |       | 0.2            |       | —         |       | —            |       |
| Operating leases (non-cancelable) |       | 15.3               |       | 5.1                     |       | 6.2            |       | 2.8            |       | 1.2               |       |
|                              |       |               |       |                    |       |           |       |           |       |              |       |
| Total Contractual                 |       | 213.9              |       | 5.7                     |       | 6.4            |       | 200.6          |       | 1.2               |       |
|                              |       |               |       |                    |       |           |       |           |       |              |       |
| Unused lines of credit            |       | $                  | 20.1       |                    | $          | 20.1           |       | $              | —     |              | $          | — |   | $ | — |   |
| Standby letters of credit         |       | 7.0                |       | 7.0                     |       | —         |       | —         |       | —            |       |
|                              |       |               |       |                    |       |           |       |           |       |              |       |
| Total Commercial                  |       | $                  | 27.1       |                    | $          | 27.1           |       | $              | —     |              | $          | — |   | $ | — |   |

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

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

 

**FACTORS AFFECTING THE COMPANY’S BUSINESS ANDPROSPECTS**

 

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

 

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***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 delivery schedules (which canadversely affect the Company’s manufacturing efficiencies) and increases incomponent costs (which can adversely affect the Company’s profitability).

 

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

 

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

 

As a result of the Company’s high debt to equity ratio, the Company isrequired to devote significant cash to debt service.   This limits the Company’s future operatingflexibility and could make the Company more vulnerable to a downturn in its operatingperformance 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 are sold.  Any unfavorable change in one or more ofthese 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 the following: customer demand andmarket acceptance of the Company’s products and solutions, new productintroductions, product obsolescence, varying product mix, foreign-currencyexchange rates, competition and other factors. The Company’s business is sensitiveto the spending patterns of its customers, which in turn are subject toprevailing economic conditions and other factors beyond the Company’s control.Any unfavorable 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.

 

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**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURE ABOUT MARKET RISK.**

 

The Company utilizes a revolving creditfacility to support working capital needs. The interest rate onloans under the Revolver is, at the Company’s option, either (1) 0.75% overprime or (2) 2.25% over LIBOR.  Although no actual balances were outstandingunder the Revolver at September 30, 2004, assuming $1.0 million inborrowings under the Revolver, a one hundred basis point change in the bank’sprime or LIBOR rate would impact net interest expense by $10,000 over atwelve-month period.

 

**ITEM 4. CONTROLS ANDPROCEDURES.**

 

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

 

The Company has addressed the individual internal-control weaknessesnoted by D&T and KPMG, but analysis of internal control factors continueson an ongoing basis.  Steps that havebeen implemented to address internal-control weaknesses include policiescovering loss contracts, inventory reserves, allowance for doubtful accounts,revenue recognition, and project costing. In addition, as a result of Exchange Act Rule 13a-14, the Company hasput in place procedures addressing the adequacy of disclosure controls,including obtaining certifications from each member of management involved inthe preparation and review of this Form 10-Q. Although the Company believes that it has implemented adequate controlsover financial reporting for the preparation of this report, the actions takenby the Company to correct certain of the previously identified weaknesses willnot be fully tested by the Company’s independent accountants until the annualaudit for the year ended December 31, 2005.

 

Within the 90 days prior to the filing date of this report, the ChiefExecutive Officer and the Chief Financial Officer of the Company, with theparticipation of the Company’s management, evaluated the effectiveness of theCompany’s disclosure controls and procedures pursuant to Exchange ActRule 13a-14.  Based upon theevaluation, and new procedures put in place, the Chief Executive Officer andthe Chief Financial Officer believe that the Company’s disclosure controls andprocedures are effective in making known to them material information relatingto the Company (including its consolidated subsidiaries) required to beincluded in this report.  The Companywill continue 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.

 

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**

 

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

 

On May 5, 2004, the Supreme Court granted the Company’s motion forsummary judgment dismissing the plaintiffs’ complaint in its entirety.  On or about November 8, 2004, theplaintiffs/appelants filed their brief with the appelate division of the NewYork Supreme Court.

 

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

 

**ITEM 2. Changes in Securities and Use 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:

 

The Company filed a Current Report on Form 8-K dated September 9,2004, reporting the termination of employment of the previous President andChief Executive Officer, Craig D. Crisman and the appointment of a newPresident and Chief Executive Officer, Coley Clark.

 

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**SIGNATURES**

 

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

 

**BancTec, Inc.**

 

 
| * *                      | *By*     | */s/  Brian R. Stone* |                                  |
|-------------------------------|----------|----------------------------|---------------------------------------|
| * *                      | * * |                       | *Brian R. Stone*                      |
| * *                      | * * | * *                   | *Senior Vice President  on behalf of* |
| * *                      | * * | * *                   | *the registrant and as  Chief*        |
| * *                      | * * |                       | *Financial Officer*                   |
| * *                      | * * |                       | * *                              |
| * *                      | * * |                       | * *                              |
| Dated: November 15, 2004 |     |                       |                                  |
|                               |          |                            |                                       |  |

 

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