**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

| **ý**                                            |   | **Quarterly Report Pursuant to  Section 13 or 15(d) of the Securities  Exchange Act of 1934**  |
|-------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|
|                                                  |   |                                                                                           |
| **For the quarterly period ended September 30, 2003** |
|                                                  |   |                                                                                           |
| **OR**                                                |
|                                                  |   |                                                                                           |
| **o**                                                 |   | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities  Exchange Act of 1934** |
|                                                  |   |                                                                                           |
| **Commission File Number 0-9859**                     |

 

**BANCTEC, INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                    |   | **75-1559633**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation  or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **2701 E. Grauwyler Road, Irving, Texas**                       |   | **75061**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |
|                                                            |   |                                 |
| **(972) 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 Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.              Yes  ý     No  o

 

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

 

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

 
| **Title of Each Class**                |   | **Number of  Shares Outstanding at  November 12, 2003** |
|----------------------------------------|--------|---------------------------------------------------------|
|                                   |   |                                                    |
| Common Stock, $0.01 par  value         |   | 17,003,838                                              |
| Class A Common Stock,  $0.01 par value |   | 1,181,946                                               |

 

 

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**PART I**

**FINANCIAL INFORMATION**

**ITEM 1.  Financial Statements**

**BANCTEC, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands, except share data)**

** **
|                                                                                                                                   |   | **September 30,  2003** |    | **December 31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                                                                   |   | **(Unaudited)**         |    |                   |   |
| CURRENT  ASSETS:                                                                                                                       |   |                    |    |                   |   |
| Cash and cash  equivalents, including restricted cash of $26,939 and $88 at September 30,  2003 and December 31, 2002                  |   | $                       | 54,962  |                   | $      | 31,595 |   |
| Accounts  receivable, less allowance for doubtful accounts of  $1,703 and $2,216 at September 30, 2003 and  December 31, 2002          |   | 50,671                  |    | 60,891                 |   |
| Inventories,  net                                                                                                                      |   | 27,954                  |    | 25,528                 |   |
| Prepaid  expenses                                                                                                                      |   | 6,208                   |    | 5,177                  |   |
| Other current  assets                                                                                                                  |   | 139                     |    | 334                    |   |
| Total current  assets                                                                                                                  |   | 139,934                 |    | 123,525                |   |
|                                                                                                                                   |   |                    |    |                   |   |
| PROPERTY,  PLANT AND EQUIPMENT, net                                                                                                    |   | 49,003                  |    | 54,782                 |   |
|                                                                                                                                   |   |                    |    |                   |   |
| OTHER ASSETS:                                                                                                                          |   |                    |    |                   |   |
| Goodwill                                                                                                                               |   | 41,476                  |    | 41,476                 |   |
| Other assets                                                                                                                           |   | 10,611                  |    | 11,612                 |   |
| Total other  assets                                                                                                                    |   | 52,087                  |    | 53,088                 |   |
| TOTAL ASSETS                                                                                                                           |   | $                       | 241,024 |                   | $      | 231,395 |   |
|                                                                                                                                   |   |                    |    |                   |   |
| CURRENT  LIABILITIES:                                                                                                                  |   |                    |    |                   |   |
| Current  obligations under capital leases                                                                                              |   | $                       | 1,096   |                   | $      | — |   |
| Trade accounts  payable                                                                                                                |   | 15,542                  |    | 12,891                 |   |
| Other accrued  expenses and liabilities                                                                                                |   | 40,664                  |    | 46,883                 |   |
| Deferred  revenue                                                                                                                      |   | 24,032                  |    | 24,107                 |   |
| Maintenance  contract deposits                                                                                                         |   | 50,952                  |    | 47,685                 |   |
| Income taxes                                                                                                                           |   | 3,540                   |    | 836                    |   |
| Total current  liabilities                                                                                                             |   | 135,826                 |    | 132,402                |   |
|                                                                                                                                   |   |                    |    |                   |   |
| OTHER  LIABILITIES:                                                                                                                    |   |                    |    |                   |   |
| Long-term  debt, less current maturities                                                                                               |   | 197,823                 |    | 201,723                |   |
| Non-current  maintenance contract deposits                                                                                             |   | 29,679                  |    | 25,933                 |   |
| Other  noncurrent liabilities                                                                                                          |   | 11,097                  |    | 9,881                  |   |
| Total other  liabilities                                                                                                               |   | 238,599                 |    | 237,537                |   |
|                                                                                                                                   |   |                    |    |                   |   |
| COMMITMENTS  AND CONTINGENCIES                                                                                                         |   |                    |    |                   |   |
|                                                                                                                                   |   |                    |    |                   |   |
| MANDATORY  REDEEMABLE PREFERRED STOCK-Series A                                                                                         |   | 16,128                  |    | 14,856                 |   |
|                                                                                                                                   |   |                    |    |                   |   |
| STOCKHOLDERS’  DEFICIT:                                                                                                           |   |                    |    |                   |   |
| Cumulative  convertible preferred stock - authorized, 1,000,000 shares of $0.01 par value  at September 30, 2003 and December 31, 2002 |   |                    |    |                   |   |
| Series B  preferred stock - issued and outstanding,  35,520 shares at September 30, 2003 and  December 31, 2002                        |   | 9,979                   |    | 8,324                  |   |
| Common stock  authorized, 22,000,000 shares of $0.01 par value at  September 30, 2003 and 32,000,000 shares at  December 31, 2002:     |   |                    |    |                   |   |
| Common  stock-issued and outstanding  17,003,838 shares at September 30, 2003 and December 31, 2002                                    |   | 170                     |    | 170                    |   |
| Class A common  stock-issued and outstanding 1,181,946 shares  at September 30, 2003 and December 31, 2002                             |   | 12                      |    | 12                     |   |
| Subscription  stock warrants                                                                                                           |   | 3,726                   |    | 3,726                  |   |
| Additional  paid-in capital                                                                                                            |   | 128,108                 |    | 131,035                |   |
| Accumulated  deficit                                                                                                                   |   | (282,472                | )       | (286,846               | )      |
| Accumulated  other comprehensive loss                                                                                                  |   | (9,052                  | )       | (9,821                 | )      |
| Total  stockholders’ deficit                                                                                                      |   | (149,529                | )       | (153,400               | )      |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                                      |   | $                       | 241,024 |                   | $      | 231,395 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

2

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**BANCTEC, INC.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
|                                                          |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|---------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                          |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                          |   | **(In thousands)**                    |   | **(In thousands)**                   |   | **(In thousands)** |   |
| REVENUE                                                       |   |                                  |   |                                 |   |   |   |   |   |
| Equipment and  software                                       |   | $                                     | 37,260 |                                 | $      | 32,888 |   | $ | 110,258 |   | $ | 101,808 |   |
| Maintenance  and other services                               |   | 60,143                                |   | 60,770                               |   | 174,940 |   | 184,705 |   |
|                                                          |   | 97,403                                |   | 93,658                               |   | 285,198 |   | 286,513 |   |
| COST OF SALES                                                 |   |                                  |   |                                 |   |   |   |   |   |
| Equipment and  software                                       |   | 23,795                                |   | 22,641                               |   | 72,510 |   | 78,012 |   |
| Maintenance  and other services                               |   | 49,568                                |   | 43,575                               |   | 141,277 |   | 137,209 |   |
|                                                          |   | 73,363                                |   | 66,216                               |   | 213,787 |   | 215,221 |   |
| Gross profit                                                  |   | 24,040                                |   | 27,442                               |   | 71,411 |   | 71,292 |   |
|                                                          |   |                                  |   |                                 |   |   |   |   |   |
| OPERATING  EXPENSES                                           |   |                                  |   |                                 |   |   |   |   |   |
| Product  development                                          |   | 3,027                                 |   | 4,150                                |   | 10,419 |   | 11,322 |   |
| Selling,  general and administrative                          |   | 11,281                                |   | 14,573                               |   | 41,453 |   | 43,236 |   |
|                                                          |   | 14,308                                |   | 18,723                               |   | 51,872 |   | 54,558 |   |
| Income from  operations                                       |   | 9,732                                 |   | 8,719                                |   | 19,539 |   | 16,734 |   |
|                                                          |   |                                  |   |                                 |   |   |   |   |   |
| OTHER INCOME  (EXPENSE):                                      |   |                                  |   |                                 |   |   |   |   |   |
| Interest  income                                              |   | 138                                   |   | 71                                   |   | 547 |   | 155 |   |
| Interest  expense                                             |   | (4,945                                | )      | (7,390                               | )      | (14,613 | ) | (22,616 | ) |
| Sundry, net                                                   |   | 173                                   |   | 516                                  |   | 1,571 |   | 4,518 |   |
|                                                          |   | (4,634                                | )      | (6,803                               | )      | (12,495 | ) | (17,943 | ) |
|                                                          |   |                                  |   |                                 |   |   |   |   |   |
| INCOME (LOSS)  FROM CONTINUING OPERATIONS BEFORE INCOME TAXES |   | 5,098                                 |   | 1,916                                |   | 7,044 |   | (1,209 | ) |
| INCOME TAX  EXPENSE                                           |   | 881                                   |   | 971                                  |   | 2,670 |   | 1,744 |   |
| INCOME (LOSS)  FROM CONTINUING OPERATIONS                     |   | 4,217                                 |   | 945                                  |   | 4,374 |   | (2,953 | ) |
| INCOME FROM  DISCONTINUED OPERATIONS,  NET  OF TAX EXPENSE    |   | —                                |   | 556                                  |   | — |   | 2,407 |   |
| INCOME (LOSS)  BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE  |   | 4,217                                 |   | 1,501                                |   | 4,374 |   | (546 | ) |
| CUMULATIVE  EFFECT OF ACCOUNTING CHANGE                       |   | —                                |   | —                               |   | — |   | (6,960 | ) |
| NET INCOME  (LOSS)                                            |   | 4,217                                 |   | 1,501                                |   | 4,374 |   | (7,506 | ) |
| PREFERRED  STOCK DIVIDENDS AND ACCRETION OF DISCOUNT          |   | (1,025                                | )      | (872                                 | )      | (2,927 | ) | (2,491 | ) |
| NET INCOME  (LOSS) APPLICABLE TO COMMON STOCK                 |   | $                                     | 3,192  |                                 | $      | 629 |   | $ | 1,447 |   | $ | (9,997 | ) |

 

See notes to unaudited condensedconsolidated financial statements.

 

3

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

 
|                                                                                                                                         |   | **Nine Months Ended September 30** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                                                         |   | **2003**                           |   | **2002** |   |
|                                                                                                                                         |   | **(In thousands)**                 |   |
| CASH FLOWS  FROM OPERATING ACTIVITIES                                                                                                        |   |                               |   |   |   |
| Net income  (loss)                                                                                                                           |   | $                                  | 4,374  |   | $ | (7,506 | ) |
| Income from  discontinued operations                                                                                                         |   | —                             |   | 2,407 |   |
| Income (loss)  from continuing operations                                                                                                    |   | 4,374                              |   | (9,913 | ) |
| Adjustments to  reconcile to cash flows provided by operations:                                                                              |   |                               |   |   |   |
| Cumulative  effect of accounting change                                                                                                      |   | —                             |   | 6,960 |   |
| Depreciation  and amortization                                                                                                               |   | 14,348                             |   | 18,152 |   |
| Provision for  doubtful accounts                                                                                                             |   | (486                               | )      | (2,100 | ) |
| Loss on  disposition of property, plant and equipment                                                                                        |   | 536                                |   | 724 |   |
| Gain on  extinguishment of long-term debt                                                                                                    |   | (1,129                             | )      | (3,387 | ) |
| Other non-cash  items                                                                                                                        |   | 42                                 |   | 291 |   |
| Changes in  operating assets and liabilities                                                                                                 |   |                               |   |   |   |
| Decrease in  accounts receivable                                                                                                             |   | 10,706                             |   | 22,709 |   |
| (Increase)  decrease in inventories                                                                                                          |   | (4,493                             | )      | 6,601 |   |
| (Increase)  decrease in other assets                                                                                                         |   | (483                               | )      | 366 |   |
| Increase  (decrease) in trade accounts payable                                                                                               |   | 2,651                              |   | (2,373 | ) |
| Increase  (decrease) in deferred revenue & maintenance contracts deposits                                                                |   | 3,192                              |   | (1,492 | ) |
| Increase  (decrease) in other accrued expenses and liabilities                                                                               |   | 2,075                              |   | (7,657 | ) |
| Cash flows  provided by continuing operations                                                                                                |   | 31,333                             |   | 28,881 |   |
| Cash flows  provided by discontinued operations                                                                                              |   | —                             |   | 2,513 |   |
| Cash flows  provided by operating activities                                                                                                 |   | 31,333                             |   | 31,394 |   |
|                                                                                                                                         |   |                               |   |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES                                                                                                        |   |                               |   |   |   |
| Purchases of  property, plant and equipment                                                                                                  |   | (4,656                             | )      | (4,977 | ) |
| Cash flows  used in continuing operations                                                                                                    |   | (4,656                             | )      | (4,977 | ) |
| Cash flows  used in discontinued operations                                                                                                  |   | —                             |   | (396 | ) |
| Cash flows  used in investing activities                                                                                                     |   | (4,656                             | )      | (5,373 | ) |
|                                                                                                                                         |   |                               |   |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES                                                                                                        |   |                               |   |   |   |
| Payments of  current maturities of long-term debt and capital lease obligations                                                              |   | (858                               | )      | — |   |
| Payments on  long-term borrowing                                                                                                             |   | (2,752                             | )      | (2,238 | ) |
| Payments on  short-term borrowings, net                                                                                                      |   | —                             |   | (15,240 | ) |
| Debt issuance  costs                                                                                                                         |   | (95                                | )      | (206 | ) |
| Cash flows  used in continuing operations                                                                                                    |   | (3,705                             | )      | (17,684 | ) |
| Cash flows  used in discontinued operations                                                                                                  |   | —                             |   | (3,798 | ) |
| Cash flows  used in financing activities                                                                                                     |   | (3,705                             | )      | (21,482 | ) |
|                                                                                                                                         |   |                               |   |   |   |
| EFFECT OF EXCHANGE  RATE CHANGES ON CASH                                                                                                     |   | 395                                |   | 1,683 |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                                                                        |   | 23,367                             |   | 6,222 |   |
| CASH AND CASH  EQUIVALENTS—BEGINNING OF PERIOD                                                                                          |   | 31,595                             |   | 22,384 |   |
|                                                                                                                                         |   |                               |   |   |   |
| CASH AND CASH  EQUIVALENTS—END OF PERIOD                                                                                                |   | $                                  | 54,962 |   | $ | 28,606 |   |
|                                                                                                                                         |   |                               |   |   |   |
| SUPPLEMENTAL  DISCLOSURES INFORMATION:                                                                                                       |   |                               |   |   |   |
| Cash paid  (refunded) during the period for:                                                                                                 |   |                               |   |   |   |
| Interest                                                                                                                                     |   | $                                  | 13,588 |   | $ | 19,065 |   |
| Taxes                                                                                                                                        |   | $                                  | (160   | ) | $ | 978 |   |
|                                                                                                                                         |   |                               |   |   |   |
| Supplemental  schedule of noncash investing and financing transactions:                                                                      |   |                               |   |   |   |
| During 2003,  capital lease obligation of $2,094 was incurred when the Company entered into  a lease for new computer hardware (See Note 7). |   |                               |   |   |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

4

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**BANCTEC,INC.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

The accompanying unaudited condensedconsolidated balance sheet at September 30, 2003, and the unaudited condensed consolidated statements ofoperations and cash flows for the interim periods ended September 30, 2003 and2002, should be read in conjunction with BancTec, Inc. and subsidiaries(“BancTec” or the “Company”) consolidated financial statements and notesthereto in the most recent Annual Report on Form 10-K filed with the Securitiesand Exchange Commission.  As disclosedin the notes to that report, the condensed consolidatedstatements of operations and cash flows for the interim periods ended September30, 2002 have been restated. In the opinion of management, the accompanying condensed consolidated financialstatements contain all material adjustments, consisting principally of normalrecurring adjustments, necessary for a fair presentation of the financialposition and results of operations of the Company. All significant intercompanybalances and transactions have been eliminated in consolidation.

 

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

 

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

 

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

 

Cash and cash equivalents include cash 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 30,2003 of $ 26.9 million represents lockbox cash receipts pledged under the termsof the Revolver.

 

**Allowancefor Doubtful Accounts**

 

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

 

**Inventories**

 

Inventories are valued at the lower of costor market and include the cost of raw materials, labor, factory overhead, andpurchased subassemblies. Cost is determined using the first-in, first-out andweighted average methods. The Company revised its standard costs formanufacturing inventory to effectively eliminate the purchasing burdencomponent as of October 1, 2002. At least quarterly, the Companyevaluates the carrying amount of inventory based on the identification ofexcess 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 incorporatesboth recent historical information and management estimates of trends. TheCompany’s approach is intended to take into consideration potential excess andobsolescence caused by a decreasing installed base, engineering changes and endof manufacture.  If any of the elementsof the Company’s estimate were to deteriorate, write-downs may be required. Theinventory write-down calculations are reviewed periodically and additionalwrite-downs are recorded as deemed necessary. Inventory reserves establish a newcost basis for inventory and are not reversed in future 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.

 

5

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**RevenueRecognition**

 

The Company derives revenue from primarily two sources- 1) productsales- systems integration solutions which address complex data andpaper-intensive work processes, including advanced web-enabled imaging andworkflow technologies with both BancTec-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,“Software Revenue Recognition,” as amended by Statement of Position 98-9“Modification of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions” to all transactions involving the sale of softwareproducts and sales of hardware where the software is not incidental. For thosetransactions that involve acceptance certificates, the Company recognizesrevenue upon receipt of the acceptance certificate, or when it can beobjectively demonstrated that acceptance criteria have been met.  For hardware transactions where software isconsidered incidental, or no software is included, revenue is recognized whenthe product has been delivered and all obligations have been fulfilled.

 

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

 

Maintenance contracts are primarily one yearin duration and the revenue generated is recognized ratably over the term ofthe contract or as service calls are performed.

 

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

 

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

 

**Researchand Development**

 

Research and development costs are expensedas incurred.

 

**IncomeTaxes**

 

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

 

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

 

**ForeignCurrency Translation**

 

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

 

6

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**Stock-BasedCompensation**

 

The Company accounts for stock-basedcompensation using the intrinsic value method prescribed in AccountingPrinciples Board (“APB No. 25”), Accounting for Stock Issued to Employees. TheCompany has adopted the disclosure requirements of Statement of FinancialAccounting Standards (“SFAS No. 123”), “Accounting for Stock-BasedCompensation” as specified in SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an amendment of SFAS No. 123.”  Accordingly, the Company continues toaccount for stock-based compensation by the intrinsic-value method anddiscloses on a pro-forma basis the effect of the fair-value method.

 

2000 Stock Plan:

 

Effective July 1, 2000, the Company adoptedthe 2000 Stock Plan (the Plan), which provides for the grant to employees ofincentive options, non-qualified stock options, and restricted stockawards.   Effective March 19, 2003, all optionsoutstanding under the 2000 Stock Plan were cancelled pursuant to an offer toexchange outstanding options dated February 14, 2003.  The offer provided that new options were to be granted not lessthan six months and one day following the closing of the exchange offer.  The new options were to be granted at thefair market value of the common stock on the date the date of grant.  Because of unanticipated accountingconsequences, the Company has cancelled plans to issue the new options,effective August 13, 2003, offered an election to rescind the exchange offer toall current employees of the Company who surrendered options in the exchangeoffer.   Employees who rescinded theexchange offer received replacement options that are identical to those theysurrendered with respect to the number of subject shares, exercise price, andvesting schedule.

 

Incentive Options. During the year endedDecember 31, 2000, 1,303,460 incentive options were granted by the Company.During 2001, 2002 and 2003, no additional incentive options were granted.  Under the Plan, incentive options aregranted at a fixed exercise price not less than 100% of the fair market valueof the shares of stock on the date of grant (or 110% of the fair market valuein certain circumstances). A portion of the incentive options vest over afour-year period at 25% per year beginning January 2, 2001; the remainder vestbased on the performance of the Company. As a part of an employee retentionprogram, vesting of 20.0% of the performance-based incentive options wasaccelerated in October 2000.    Theseoptions were part of the same offer to exchange and subsequent rescission ofthe offer to exchange described above.

 

Non-qualified stock options. During the yearended December 31, 2000, 377,040 non-qualified stock options were granted by theCompany. During 2001, 2002 and 2003, no additional non-qualified options weregranted.  Under the Plan, non-qualifiedoptions are granted at a fixed exercise price equal to, more than, or less than100% of the fair market value of the shares of stock on the date of grant. Aportion of the non-qualified options vest over a four-year period at 25% peryear beginning January 2, 2001; the remainder vest based on the performance ofthe Company. As a part of an employee retention program, vesting of 20.0% of theperformance-based incentive options was accelerated in October 2000.  These options were part of the same offer toexchange and subsequent rescission of the offer to exchange described above.

 

Restricted stock awards. The amount, if any,to be paid by the award recipient to acquire the shares of stock pursuant to arestricted stock-award is a fixed exercise price equal to, more than, or lessthan 100% of the fair market value of the shares of stock subject to the awardon the date of grant. The restricted stock awards are subject to vestingprovisions determined by the Company’s Board of Directors. At September 30,2003, no restricted stock-awards had been granted.

 
|                                         |   | **Incentive  Shares** |   | **Non-qualified  Shares** |   | **Weighted  Average  Exercise  Price** |   |
|----------------------------------------------|--------|-----------------------|--------|---------------------------|--------|----------------------------------------|--------|
| Options  outstanding–December 31, 2001  |   | 632,240               |   | 31,760                    |   | 9.25                                   |   |
| Forfeited                                    |   | (135,000              | )      | —                    |   | 9.25                                   |   |
| Options  outstanding–December 31, 2002  |   | 497,240               |   | 31,760                    |   | 9.25                                   |   |
| Forfeited                                    |   | (33,500               | )      | —                    |   | 9.25                                   |   |
| Cancelled                                    |   | —                |   | —                    |   | 9.25                                   |   |
| Options  outstanding–September 30, 2003 |   | 463,740               |   | 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 pursuant to termination or oneyear after the date the employee ceases to be employed by the Company pursuantto death or disability.

 

7

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At September 30, 2003, options to purchase495,500 shares were outstanding, of which 235,363 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.  There were no stock options granted in 2002 or 2003.

 

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

 
|                                                                                                                             |   | **Three Months Ended March 31,** |   | **Nine Months Ended September 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|-------------------------------------|--------|
|                                                                                                                             |   | **2003**                         |   | **2002**                            |   | **2003** |   | **2002** |   |
| Net Income  (loss) as reported                                                                                                   |   | $                                | 4,217  |                                | $      | 1,501 |   | $ | 4,374 |   | $ | (7,506 | ) |
| Total stock-based employee compensation  benefit (expense) determined under fair-value-based method for all rewards,  net of tax |   | 4                                |   | 330                                 |   | 12 |   | 990 |   |
| Pro-Forma net  income (loss)                                                                                                     |   | $                                | 4,221  |                                | $      | 1,831 |   | $ | 4,386 |   | $ | (6,516 | ) |

 

**3.****                                      DISCONTINUED OPERATIONS**

 

On November 27, 2002, the Company completedthe sale of its wholly-owned subsidiary, BancTec Japan (“BTJ”), to JAFCO MBOCo., Ltd. (“JAFCO”) pursuant to a Stock Purchase Agreement dated as of November27, 2002, between the Company and JAFCO. The sale involved two separate transactions: (1) the purchase by JAFCOof 100% of the outstanding shares of BTJ for 6.5 billion yen, and (2) a one-time,up-front payment by BTJ to the Company of 4.0 billion yen under certaindistribution and licensing agreements. Under such agreements, BTJ will continue to operate under the name“BancTec Japan”.  After foreign currencyconversions and transaction costs, the Company received approximately US $82.5million in aggregate net proceeds.  Forfinancial statement purposes, the Company treated the sale as a discontinuedoperation under SFAS No. 144, and accordingly, financial statement presentationwas made in accordance with APB Opinion No. 30.  BTJ’s operating results have been segregated and reported asdiscontinued operations in the accompanying consolidated statements of incomeand cash flows, and related notes. Revenue from the discontinued operations of BTJ for the three months andnine months ended September 30, 2002 was $15.2 million and $51.7 million,respectively.  Pretax income from thediscontinued operations of BTJ for the three months and nine months endedSeptember 30, 2002 was $1.0 million and $4.2 million, respectively.   The assets related to BTJ were previouslyclassified in the International segment.

 

**4.             INVENTORIES**

 

Inventory consists of the following:

 

|             |   | **September 30,  2003** |   | **December 31,  2002** |   |
|------------------|--------|-------------------------|--------|------------------------|--------|
|             |   | **(In thousands)**      |   |
| Raw materials    |   | $                       | 6,814  |                   | $      | 5,374 |   |
| Work-in-progress |   | 11,033                  |   | 9,995                  |   |
| Finished goods   |   | 10,107                  |   | 10,159                 |   |
|             |   | $                       | 27,954 |                   | $      | 25,528 |   |

 

8

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**5.             PROPERTY, PLANT AND EQUIPMENT**

 

Property, plant and equipment consist of thefollowing:

 

|                                       |   | **September 30,  2003** |   | **December 31,  2002** |   |
|--------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                       |   | **(In thousands)**      |   |
| Land                                       |   | $                       | 2,860  |                   | $      | 2,860 |   |
| Field support  spare parts                 |   | 59,448                  |   | 58,339                 |   |
| Systems and  software                      |   | 55,490                  |   | 64,604                 |   |
| Machinery and  equipment                   |   | 19,610                  |   | 50,053                 |   |
| Furniture,  fixtures and other             |   | 22,270                  |   | 22,953                 |   |
| Buildings                                  |   | 28,316                  |   | 29,006                 |   |
|                                       |   | 187,994                 |   | 227,815                |   |
| Accumulated  depreciation and amortization |   | 138,991                 |   | 173,033                |   |
| Property,  plant and equipment, net        |   | $                       | 49,003 |                   | $      | 54,782 |   |

 

**6.             OTHER ACCRUED EXPENSES ANDLIABILITIES**

 

Other accrued expenses and liabilitiesconsist of the following:

 

|                                    |   | **September 30,  2003** |   | **December 31,  2002** |   |
|-----------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                    |   | **(In thousands)**      |   |
| Salaries,  wages and other compensation |   | $                       | 11,153 |                   | $      | 12,169 |   |
| Accrued taxes,  other than income taxes |   | 6,226                   |   | 8,794                  |   |
| Advances from  customers                |   | 1,448                   |   | 586                    |   |
| Accrued  interest payable               |   | 4,972                   |   | 4,951                  |   |
| Accrued  invoices and costs             |   | 2,070                   |   | 2,395                  |   |
| Accrued  contract completion costs      |   | 3,333                   |   | 4,590                  |   |
| Other                                   |   | 11,462                  |   | 13,398                 |   |
|                                    |   | $                       | 40,664 |                   | $      | 46,883 |   |

 

**7.             DEBT AND OTHER OBLIGATIONS**

 

Debt and other obligations consist of thefollowing:

 

|                                            |   | **September 30,  2003** |    | **December 31,  2002** |   |
|-------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                            |   | **(In thousands)**      |    |
| 7.5% Senior  Notes, due 2008                    |   | $                       | 93,975  |                   | $      | 97,875 |   |
| Subordinated  Sponsor Note, unsecured, due 2009 |   | 103,848                 |    | 103,848                |   |
|                                            |   | 197,823                 |    | 201,723                |   |
| Less:  Current portion                     |   | —                  |    | —                 |   |
|                                            |   | $                       | 197,823 |                   | $      | 201,723 |   |

 

9

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Revolving Credit Facility.  The Company has a revolving credit facility(the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which willmature on May 30, 2006.   Effective May7, 2003, the Company and Heller entered into an amendment to the Revolver whichreduced the committed amount from $60 million to $40 million, while increasingthe letter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.   OnNovember 27, 2002, the Company and Heller entered into an amendment to theRevolver that added pledged cash to the borrowing base.   Funds availability under the Revolver isdetermined by a borrowing-base formula equal to a specified percentage of thevalue of the Company’s eligible accounts receivable, inventory and pledgedcash.  At September 30, 2003, theCompany had no balance outstanding under the Revolver and an outstandingbalance on letters-of-credit totaling $22.8 million.  The balance remaining under the Revolver that the Company candraw was $13.1 million at September 30, 2003 ($17.1 million in availabilityless a $4.0 million reserve).  A commitmentfee of 0.5% per annum on the unused portion of the Revolver is payablequarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 1.00% over prime or (2) 2.50% over LIBOR.  Under an amendment effective September 1,2003, the interest-rate margins over prime and LIBOR may be increased by 0.25%increments when the fixed charge coverage ratio falls below (1) 1.75 to 1.0,(2) 1.5 to 1.0 and (3) 1.25 to 1.0 (total rate increase of 0.75%) or decreasedby 0.25% increments when the fixed charge coverage ratio is greater than (3)2.0 to 1.0 and (4) 2.25 to 1.0 (total rate decrease of 0.5%).  The interest-rate was remeasured as of theeffective date of September 1, 2003 under this amendment.  At September 30, 2003, the Company’sweighted average rate on the Revolver was 5.0%.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing-base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at September 30, 2003 of $26.9 million representslockbox cash receipts to be applied to the outstanding borrowings under theRevolver and cash 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 borrowing availability.At September 30, 2003, the Company was in compliance with all covenants underthe Revolver.

 

Senior Notes. Interest on the Senior Notes is fixed at 7.5% and is due and payable insemi-annual installments. Payments began December 1, 1998. The Notes containcovenants placing limitations on the Company’s ability to permit subsidiariesto incur certain debts, incur certain loans, and engage in certain sale andleaseback transactions. During the firstnine months of 2003, the Company repurchased Senior Notes with a face amount 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 periods ended September 30, 2003.  Theestimated fair value of the Senior Notes as of September 30, 2003, is approximately$60.5 million based on an average value of the most recently completed markettrades, resulting in a yield-to-maturity of approximately 20%.  The number of actual trades is limited;therefore the result may vary if a widely traded market environment existed.

 

Subordinated Unsecured Sponsor Note. TheCompany’s Sponsor Note bears interest at 10.0%, due and payable quarterly. TheSponsor Note is subordinate only upon bankruptcy or insolvency of the Company,or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. Asprovided under the agreement, however, the Sponsor Note holder, Welsh, Carson,Anderson & Stowe (“WCAS’), elected to defer quarterly interest payments of$4.0 million for each of the September 2000 through September 2001 quarterlyperiods resulting in an increase in the principal amount of the Sponsor Notetotaling $33.8 million.  Such electionrequired a deferred financing-fee of 30.0% of each of the interest paymentsbeing deferred.  The Company accountsfor the additional financing fees as a change in the effective interest rate ofthe debt. WCAS may, at its election, defer each future quarterly payment undersimilar terms.  WCAS has not elected todefer the quarterly payments since September 2001.  In accordance with the terms of the Sponsor Note, on December 6,2002, the Company made a $90.0 million principal payment on the SponsorNote.  A holder of the Senior Notes iscontesting this payment.  See discussionunder Legal Proceedings.  The estimatedfair-value of the Sponsor Note and deferred interest and fees as of September30, 2003, is approximately $58.2 million assuming a yield-to-maturity of 25%.

 

The Company had no outstanding balances onforeign credit agreements at September 30, 2003.

 

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

 

10

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**8.             GOODWILL AND INTANGIBLE ASSETS**

 

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

 

SFAS No. 142 requires a two-step process for testing impairment. First,the fair-value of each reporting unit is compared to its carrying value todetermine whether an indication of impairment exists. If impairment isindicated, then under the second step the fair-value of the reporting unit’sgoodwill is determined by allocating the unit’s fair-value to its assets andliabilities (including any unrecognized intangible assets) as if the reportingunit had been acquired in a business combination. The amount of impairment forgoodwill is measured as the excess of its carrying value over itsfair-value.  During the first quarter of2002, the Company recorded as a cumulative effect of a change in accountingprinciple, a non-cash charge of $6.9 million, after applicable income taxes, towrite off a portion of the carrying value of goodwill.

 

Components of the Company’s goodwill include amounts that areforeign-currency denominated.  Thesegoodwill amounts are subject to translation at each balance sheet date.  The Company records the change to itsAccumulated Other Comprehensive Loss on the balance sheet.  Goodwill previously classified asunallocated has been allocated to the reporting units as required by SFAS No.142. The following is a summary of changesin the carrying amount of goodwill by segment for the nine months endedSeptember 30, 2003:

 
|                          |   | **US  Solutions**  |   | **Computer  & Network  Services** |   | **International** |   | **Unallocated** |   | **Total** |   |
|-------------------------------|--------|--------------------|--------|---------------------------------------|--------|-------------------|--------|-----------------|--------|-----------|--------|
|                          |   | **(In thousands)** |   |
|                          |   |               |   |                                  |   |              |   |            |   |      |   |
| Balance at December 31, 2002  |   | $                  | 41,236 |                                  | $      | —            |   | $               | 240    |      | $      | — |   | $ | 41,476 |   |
| Goodwill impairment           |   | —             |   | —                                |   | —            |   | —          |   | —    |   |
| Balance at September 30, 2003 |   | $                  | 41,236 |                                  | $      | —            |   | $               | 240    |      | $      | — |   | $ | 41,476 |   |

 
|                                           |   | **US  Solutions**   |   | **Computer  & Network  Services** |   | **International** |   | **Unallocated** |   | **Total** |   |
|------------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|-------------------|--------|-----------------|--------|-----------|--------|
|                                           |   | **(In  thousands)** |   |
| Balance at December 31, 2001                   |   | $                   | 40,211 |                                  | $      | —            |   | $               | 2,229  |      | $      | 5, 841 |   | $ | 48,281 |   |
| Allocation of previously unallocated  goodwill |   | 1,025               |   | —                                |   | 4,816             |   | (5,841          | )      | —    |   |
| Goodwill impairment                            |   | —              |   | —                                |   | (6,960            | )      | —          |   | (6,960    | )      |
| Changes due to foreign currency translation    |   | —              |   | —                                |   | 155               |   | —          |   | 155       |   |
| Balance at September 30, 2002                  |   | $                   | 41,236 |                                  | $      | —            |   | $               | 240    |      | $      | — |   | $ | 41,476 |   |

 

**9.             WARRANTY LIABILITY**

 

The Company offers various product warranties for hardwaresold to its customers.  The specific terms and conditions of the warrantiesvary depending upon the customer and the product sold.  Factors thataffect the Company’s warranty liability include number of products sold,historical and anticipated rates of warranty claims and cost per claim. The Company accrues for estimated warranty costs as sales are made andperiodically assesses the adequacy of its recorded warranty liability andadjusts the amount as necessary.

 

Changes to the Company’s warranty liability, which isreported as a component of other accrued expenses and liabilities in theaccompanying condensed consolidated balance sheet during the nine months endedSeptember 30, 2003 are summarized as follows:

 

11

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|                                              |   | **(In  thousands)** |   |
|---------------------------------------------------|--------|---------------------|--------|
| Balance at December 31, 2002                      |   | $                   | 139    |   |
| Warranties issued                                 |   | 75                  |   |
| Claims paid/settlements                           |   | (156                | )      |
| Changes in liability for pre-existing  warranties |   | —              |   |
| Balance at September 30, 2003                     |   | $                   | 58     |   |

 

**10.          COMPREHENSIVE INCOME (LOSS)**

 

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

 
|                                     |   | **Three  Months Ended September 30,** |   | **Nine  Months Ended September 30,** |   |
|------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                     |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                     |   | **(In  thousands)**                   |   | **(In  thousands)**                  |   |
| Net income (loss)                        |   | $                                     | 4,217  |                                 | $      | 1,501 |   | $ | 4,374 |   | $ | (7,506 | ) |
| Foreign currency translation adjustments |   | 132                                   |   | (255                                 | )      | 769 |   | 2,198 |   |
| Total comprehensive income (loss)        |   | $                                     | 4,349  |                                 | $      | 1,246 |   | $ | 5,143 |   | $ | (5,308 | ) |

 

**11.          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, 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 three  months ended September 30, 2002 |   |               |   |                                  |   |              |   |           |   |      |   |
|                                           |   |               |   |                                  |   |              |   |           |   |      |   |
| Revenue from  external customers               |   | $                  | 34,652 |                                  | $      | 35,495            |   | $              | 23,511 |      | $      | — |   | $ | 93,658 |   |
| Intersegment  revenue                          |   | 559                |   | —                                |   | 3,570             |   | (4,129         | )      | —    |   |
| Segment gross  profits                         |   | 9,716              |   | 10,281                                |   | 6,738             |   | 707            |   | 27,442    |   |
| Segment  operating income (loss)               |   | 1,273              |   | 7,404                                 |   | 869               |   | (827           | )      | 8,719     |   |

 

12

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|                                          |   | **US  Solutions**  |    | **Computer  & Network  Services** |   | **International** |   | **Corp/Elims** |   | **Total** |   |
|-----------------------------------------------|--------|--------------------|---------|---------------------------------------|--------|-------------------|--------|----------------|--------|-----------|--------|
|                                          |   | **(In thousands)** |    |
| 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     |   |
|                                          |   |               |    |                                  |   |              |   |           |   |      |   |
| For the nine  months ended September 30, 2002 |   |               |    |                                  |   |              |   |           |   |      |   |
|                                          |   |               |    |                                  |   |              |   |           |   |      |   |
| Revenue from  external customers              |   | $                  | 110,130 |                                  | $      | 107,662           |   | $              | 68,721 |      | $      | — |   | $ | 286,513 |   |
| Intersegment  revenue                         |   | 1,596              |    | —                                |   | 11,505            |   | (13,101        | )      | —    |   |
| Segment gross  profits                        |   | 23,215             |    | 26,735                                |   | 20,304            |   | 1,038          |   | 71,292    |   |
| Segment  operating income (loss)              |   | (1,555             | )       | 18,380                                |   | 3,599             |   | (3,690         | )      | 16,734    |   |
| Segment  identifiable assets                  |   | 101,673            |    | 36,060                                |   | 47,903            |   | 49,269         |   | 234,905   |   |
| Capital  appropriations                       |   | 2,713              |    | 951                                   |   | 1,058             |   | 255            |   | 4,977     |   |

 

**12.         PREFERRED STOCK**

 

**MANDATORYREDEEMABLE 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. The related discount is being accretedsuch that the carrying amount of the mandatory redeemable preferred stock willequal the mandatory redemption amount at September 22, 2008. For the ninemonths ended September 30, 2003, accretion of the related discount and accrued but unpaid dividendstotaled $1.3 million, increasing the carrying amount to $16.1 million. As ofSeptember 30, 2003, the stated value of theSeries A preferred stock, including accumulated but unpaid dividends, was$184.56 per share.    Beginning with thequarter ended March 31, 2004, the mandatory redeemable preferred stockissued by the Company will be reclassified to the liability section of thebalance sheet as required by SFAS 150 and will initially be measured at fairvalue.

 

**SERIES B PREFERREDSTOCK**

 

For the nine months ended September30, 2003, the Company accrued additionalunpaid dividends for its Series B preferred stock totaling $1.7 million,increasing the carrying amount to $10.0 million.  As of September 30, 2003, the stated value of the Series B preferred stock, including accumulatedbut unpaid dividends, was $280.95 per share.

 

**13.          RECENT ACCOUNTING PRONOUNCEMENTS**

 

In August 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations.” SFAS No. 143 requires entities to record the fairvalue of a liability for an asset retirement obligation in the period in whichit is incurred. The Company adopted SFAS No. 143 on January 1, 2003 with noimpact to its financial position and results of operations.

 

In July 2002, the FASB issued SFAS No. 146,“Accounting for Exit or Disposal Activities”. This statement requires companies to recognize costs associated withexit or disposal activities when they are incurred rather than at the date of acommitment to an exit or disposal plan. SFAS No. 146 nullifies EITF Issue No. 94-3, “Liability Recognition forCertain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring),” and will be appliedprospectively to exit or disposal activities initiated after December 31,2002.  The Company adopted SFAS No. 146on January 1, 2003 with no impact to the Company’s financial statements.

 

In December 2002, the FASB issued SFAS No.148, “Accounting for Stock-Based Compensation—Transition and Disclosure—anamendment of SFAS No. 123.”  Thisstatement provides alternative methods of transition for a voluntary change tothe fair-value based method of accounting for stock-based employeecompensation.  This statement alsoamends the disclosure requirements of SFAS No. 123 and APB Opinion No. 28,“Interim Financial Reporting,” to require prominent disclosures in both annualand interim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportedresults.  The Company implemented SFASNo. 148 on January 1, 2003, regarding disclosure requirements for condensedfinancial statements for interim periods. The Company has not yet determined whether it will voluntarily change tothe fair-value based method of accounting for stock-based employee compensation

 

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In November 2002, the FASB issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (“FIN 45”). It clarifies that a guarantoris required to recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee, including itsongoing obligation to stand ready to perform over the term of the guarantee inthe event that the specified triggering events or conditions occur. The objectiveof the initial measurement of the liability is the fair value of the guaranteeat its inception. The initial recognition and initial measurement provisions ofFIN 45 are effective on a prospective basis to guarantees issued after December31, 2002.  However, the disclosurerequirements are effective for interim and annual financial-statement periodsending after December 15, 2002. The Company has adopted FIN 45 with no impacton the Company’s results of operations or financial position.

 

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”). FIN46 requires that unconsolidated variable-interest entities be consolidated bytheir primary beneficiaries. A primary beneficiary is the party that absorbs amajority of the entity’s expected losses or residual benefits. FIN 46 appliesimmediately to variable-interest entities created after January 31, 2003 and toexisting variable-interest entities in the periods beginning after June 15,2003.  The Company has adopted FIN 46with no effect on the Company’s results of operations or financial position.

 

In November 2002, the FASB’s Emerging Issues Task Force (“EITF”)reached a consensus on Issue 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables,” which must be applied to all revenue arrangementsentered into no later than June 30, 2003. EITF 00-21 governs how toidentify whether goods or services or both that are to be delivered separatelyin a bundled sales arrangement should be accounted for separately. Theappropriate accounting literature for revenue recognition would then be appliedto each unit.  The Company has adoptedthe consensus reached in EITF 00-21 with no impact on the Company’s results ofoperations or financial position.

 

In June 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity.” Thestatement is effective for financial instruments entered into or modified afterMay 31, 2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003, except for mandatorily redeemable financialinstruments of a nonpublic entity.  Formandatorily redeemable financial instruments of a nonpublic entity, thisstatement shall be effective for fiscal periods beginning after December 15,2003.  The mandatory redeemablepreferred stock issued by the Company will be reclassified to the liabilitysection of the balance sheet as required by SFAS 150 during the quarter endedMarch 31, 2004.  It is not anticipatedthat the adoption of this statement, however, will have a material effect onour results of operations.

 

**14.   SUBSEQUENT EVENTS**

 

None

 

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

**RESULTSOF OPERATIONS.**

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

*This Quarterly Report on Form 10-Q, includingFactors Affecting the Company’s Business and Prospects set forth inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and Quantitative and Qualitative Disclosure About Market Risk,contains forward-looking statements as that term is defined in the PrivateSecurities Litigation Reform Act of 1995 (the “PSLRA”) that involve risks anduncertainties, as well as assumptions that, if they never materialize or proveincorrect, could cause the results of BancTec, Inc. and its consolidatedsubsidiaries (the “Company”) to differ materially from those expressed orimplied by such forward-looking statements. All statements other thanstatements of historical fact are statements that could be deemedforward-looking statements, including any projections of earnings, revenue, orother financial items; any statements of the plans, strategies, and objectivesof management for future operations; any statements concerning proposed newproducts, services, or developments; any statements regarding future economicconditions or performance; statements of belief and any statement ofassumptions underlying any of the foregoing. The risks, uncertainties andassumptions referred to above include the ability of the Company to retain andmotivate key employees; the timely development, production and acceptance ofproducts and services and their feature sets; the challenge of managing assetlevels, including inventory; the flow of products into third-party distributionchannels; the difficulty of keeping expense growth at modest levels whileincreasing revenue; and other risks that are described from time to time in theCompany’s Securities and Exchange Commission reports, including but not limitedto 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.*

 

The Company believes severalfactors continued to create a challenging and competitive sales and costcontainment environment during the nine months ended September 30, 2003.  These factors include: general economicconditions and reduced corporate customer technology spending, ongoingcompetitive pressures, and a highly leveraged financial position.

 

Expected economic and businessconditions for the remainder of 2003 indicate a cautious outlook regarding theCompany’s near-term revenue and earnings growth prospects.  Most of the Company’s product offeringsrepresent a significant capital expenditure for its customers.  The Company has concentrated its emphasis oncost reductions and on existing offerings. Product-development efforts arecurrently focused on payment, check and document processing technologies, inaddition to investments in Electronic Document Management (“EDM”) verticalsolutions and an investment in archiving solutions for all markets, as well ashardware 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.

 

**RESULTSOF OPERATIONS**

 

**Comparisonof Three Months Ended September 30, 2003 and Three Months Ended September 30,2002**

 

Consolidated revenue of $97.4 million for thethree months ended September 30, 2003 increased by $3.7 million or 3.9% fromthe comparable prior-year period. US Solutions (“USS”) revenue increased $0.1million.  Increases resulting fromstrengthening demand for the Company’s system integration services were offsetby declines in maintenance revenue due to Company installed products reachingthe end of their useful lives and from increased competition.  Increases in International (“INTL”) of $4.2million are the result of the introduction in the United Kingdom of documentprocessing services and the impact of the weakening dollar on the conversion ofrevenue stated in foreign currencies.  Adecrease in Computer & Network Services (“CNS”) of $0.6 million resultedfrom pricing decreases resulting from competitive pressure, as well asdecreased volume under certain maintenance programs.  The Company expects these trends to continue in the foreseeablefuture. Factors impacting future revenue include corporate-customer spendingfor large systems-solutions, customer and prospective customer mergers,on-going competitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $24.0 milliondecreased by $3.4 million or 12.4% from the comparable prior-year period.Decreases in USS of $0.9 million and in CNS of $5.2 million were partiallyoffset by an increase in INTL of $3.6 million. Although overall USS revenue increased, the lower USS gross profitresulted from changes in the revenue mix. The USS gross margin percentage decreased from 27.6% to 24.9%.  Declining maintenance revenue has beenreplaced with system integration revenue carrying a lower gross profitpercentage.  Increases in INTL grossprofit resulted partially from increased revenue, including the impact ofcurrency conversion, and partially from a higher gross profit percentage,increasing from 24.9% to 35.0%. Continued efforts to provide provendeliverables as well as targeted new offerings, including EDMsolutions, archive solutions and hardware enhancements, which, along

 

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with ongoing cost-containment efforts, allowed for cost reductions tostrengthen the INTL gross profit.  CNS’ gross profit decrease resultedprimarily from decreased revenue as well as margin pressure caused by increasedcompetition and changes in the revenue mix.

 

Operating expenses of $14.3 million decreased$4.4 million compared to the prior-year period. Operating expenses, bycomponent, changed as follows: Product-development expenses decreased by $1.1million or 28.6% 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”) decreased by $3.3 million or22.6% due to decreased SG&A depreciation expense and theimpact of the weakening dollar on the conversion of expenses stated in foreigncurrencies.

 

Interest expense for the threemonths ended September 30, 2003  decreased to $4.9 million from $7.4 million inthe comparable prior-year period. The decrease was due mainly to thepayment of $90.0 million on the Sponsor Note in December 2002, the repurchaseof a portion of the Senior Notes.

 

Sundry items resulted in a net income of $0.2 million during the threemonths ended September 30, 2003 ascompared to a net income of $0.5 million during the comparable prior-year period. This decrease is primarily due to foreign-exchange gains of $0.1 millionduring the current-year period, compared to a gain from the repurchase ofSenior Notes of approximately $0.5 million and foreign-exchange losses of $0.1million in the prior-year period.

 

Pre-tax income in foreign tax jurisdictions resulted in an income taxprovision of $0.9 million for the three months ended September 30, 2003 compared to a correspondingprior-year period income tax provision of $1.0 million.  The income tax provisions for both periodsrelated primarily to income from the Company’s international subsidiaries.  The Company’s effective tax rate wasapproximately 17.3% for the three months ended September 30, 2003 as compared to 50.7% for the corresponding prior-yearperiod.

 

**Comparisonof Nine Months Ended September 30, 2003 and Nine Months Ended September 30,2002**

 

Consolidated revenue of $285.2 million forthe nine months ended September 30, 2003 decreased by $1.3 million or 0.5% fromthe comparable prior-year period. Decreases in USS of $4.7 million resultedprimarily from the overall weakness in hardware sales during the first quarterof 2003.  In addition, USS experienceddeclines in maintenance revenue due to Company installed products reaching theend of their useful lives and from increased competition.  Increases in INTL of $12.4 million are aresult of strengthening demand in Europe and the United Kingdom for theCompany’s software products, the introduction in the United Kingdom of documentprocessing services during 2003, and the impact of the weakening dollar on theconversion of revenue stated in foreign currencies.  A decrease in CNS of $9.0 million resulted from pricing decreasesresulting from competitive pressure, as well as decreased volume under certainmaintenance programs.   Factors thatmost impact future revenue include corporate-customer spending for largesystems-solutions, customer and prospective customer mergers, on-goingcompetitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $71.4 millionincreased by $0.1 million or 0.1% from the comparable prior-year period.Increases in USS of $1.3 million and in INTL of $8.6 million were partiallyoffset by decreases in CNS of $8.7 million. Despite decreased revenue in USS, gross profit increased due to theCompany’s cost-containment efforts. The gross profit percentage increased forUSS also increased from 20.8% to 22.9%. The INTL increase resulted primarilyfrom increased revenue, including the impact of currency conversion, and anincrease in gross profit percentage resulting from cost-containment efforts.  The Company is in the processof transitioning its product offering focus on proven deliverables and newtargeted offerings, including EDM solutions, its other archive solutions andhardware upgrades.  Incorporating morethird-party products into the Company’s solutions rather than developing theproducts has enabled the concentration of efforts and expenditures on thetargeted items which, along with the Company’s ongoing cost-containmentefforts, allowed for cost reductions to help offset revenue declines.  CNS’gross profit decrease resulted primarily from decreased revenue as wellas margin pressure caused by increased competition and a change in revenue mix.

 

Operating expenses of $51.9 million decreased$2.7 million compared to the prior-year period. Operating expenses, by component,changed as follows: Product-development expenses decreased by $0.9 million or8.0% primarily due to the focused realignment of research and developmentexpenditures against future product strategies and marketing plans.  The use of outsourced product-developmentservices also contributed to the reduction.  Selling, general, and administrative expenses decreased by $1.8 millionor 3.9% due to decreases in depreciation expense and decreasesgenerated by the Company’s ongoing cost-containment efforts.

 

Interest expense for the ninemonths ended September 30, 2003  decreased to $14.6 million from $22.6 million inthe comparable prior-year period. The decrease was due mainly to thepayment of $90.0 million on the Sponsor Note in December 2002, the repurchaseof a portion of the Senior Notes.

 

Sundry items resulted in a net income of $1.6 million during the ninemonths ended September 30, 2003 ascompared to a net income of $4.5 million during the comparable prior-year period. This decrease is primarily due to a gain of approximately $1.1 millionfrom

 

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the Company’s repurchase of Senior Notes andforeign-exchange gains of $0.4 million during the current-year period, comparedto a gain on the repurchase of Senior Notes of $3.4 million andforeign-exchange gains of $1.0 million in the prior-year period.

 

Pre-tax income in foreign tax jurisdictions resulted in an income taxprovision of $2.7 million for the nine months ended September 30, 2003 compared to a correspondingprior-year period income tax provision of $1.7 million.  The income tax provisions for both periodsrelated primarily to income from the Company’s international subsidiaries.  The Company’s effective tax rate wasapproximately 37.9% for the nine months ended September 30, 2003 as compared to (144.3)% for the corresponding prior-yearperiod.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

The Company’s working capitalrequirements 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 cash flowsfrom operations. Funds availability under the revolving credit agreement isdetermined by a borrowing-base formula equal to a specified percentage of thevalue of the Company’s eligible accounts receivable, inventory and pledgedcash.  General economic conditions, thecurrent weakness 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 $55.0 million at September 30, 2003, compared with $31.6 million at December 31,2002. Working capital increased $13.0 million during the nine months endedSeptember 30, 2003 to a positiveworking capital of $4.1 million compared to a working-capital deficit of $8.9million at December 31, 2002.  Thechange in working capital included a current liability decrease of $3.0 millionfrom decreased deferred revenue and maintenance contract deposits andaccrued expenses, an accounts payable increase of $2.7 million, an accounts receivable decrease of $10.2 million andan inventory increase of $2.5 million.

 

During the nine months ended September30, 2003, the Company relied primarily oncash flows generated from operating activities and short-term borrowings underits revolving credit agreement tofund operations. At September 30, 2003, the Company had available $39.9 million of borrowing capacity under theRevolver, of which the Company can draw $13.1 million ($17.1 million inavailability less a $4.0 million reserve).

 

Operating activities provided $31.3 millionand $31.4 million of cash in the nine months ended September 30,2003 and 2002, respectively, a decreaseof  $0.1 million.  Although net income from continuingoperations increased $14.3 million, $7.3 million of this improvement resultedfrom lower depreciation and amortization and other non-cash transactions.  In addition, cash generated by changes inworking capital assets and liabilities was $4.5 million less than in theprior-year period.

 

Investing activities used net cash of $4.7million and $5.4 million in the nine months ended September 30,2003 and 2002, respectively. Both uses ofcash related to purchases of property, plant and equipment.

 

Financing activities used $3.7 million and$21.5 million of net cash in the nine months ended September 30,2003 and 2002, respectively.  Both uses of cash related primarily to thereduction of the Company’s debt.

 

At September 30, 2003, 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 in compliance with thecovenants of its debt instruments.

 

The Company continually reviewsits various lines of business to assess their contribution to the Company’sbusiness plan and from time to time considers the sale of certain assets inorder to raise cash or reduce debt. Accordingly, the Company from time to time has explored and may explorepossible asset sales by seeking expressions of interest from potential bidders.  However, the Company has not entered intoany binding agreements or agreements in principle to sell any assets and therecan be no assurance that any such asset sales will occur or, if they occur, asto the timing or amount of proceeds that such asset sales may generate.

 

**Revolving CreditFacility.**The Company has a revolving credit facility(the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which willmature on May 30, 2006.   Effective May7, 2003, the Company and Heller entered into an amendment to the Revolver whichreduced the committed amount from $60 million to $40 million, while increasingthe letter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.   OnNovember 27, 2002, the Company and Heller entered into an amendment to theRevolver that added pledged cash to the borrowing base.   Funds availability under the Revolver isdetermined by a borrowing-base formula equal to a specified percentage of thevalue of the Company’s eligible accounts receivable, inventory and pledgedcash. At September 30, 2003, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $22.8million.  The balance remaining underthe Revolver that the Company can draw was $13.1 million at September 30,

 

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2003 ($17.1 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 1.00% over prime or (2) 2.50% over LIBOR.  Under an amendment effective September 1,2003, the interest-rate margins over prime and LIBOR may be increased by 0.25%increments when the fixed charge coverage ratio falls below (1) 1.75 to 1.0,(2) 1.5 to 1.0 and (3) 1.25 to 1.0 (total rate increase of 0.75%) or decreasedby 0.25% increments when the fixed charge coverage ratio is greater than (3)2.0 to 1.0 and (4) 2.25 to 1.0 (total rate decrease of 0.5%).  The interest-rate was remeasured as of theeffective date of September 1, 2003 under this amendment.  At September 30, 2003, the Company’s weightedaverage rate on the Revolver was 5.0%.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing-base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at September 30, 2003 of $26.9 million representslockbox cash receipts to be applied to the outstanding borrowings under theRevolver and cash pledged under the terms of the Revolver.  The Revolver contains variousrepresentations, warranties and covenants, including financial covenants as tomaximum capital expenditures, minimum fixed-charge coverage ratio and minimumaverage borrowing availability.  AtSeptember 30, 2003, the Company was in compliance with all covenants under theRevolver.  On July 30, 2002, the Company and Heller amended the Revolver, whichreduced the Company’s fixed-charge coverage ratio covenant during the first,second, and third quarters of 2002, and reduced the minimum undrawnavailability requirement from $10.0 million to $4.0 million.

 

**SeniorNotes**. In August 1998,the Company exchanged the public Senior Notes (the “Senior Notes”) for thenotes sold in a May 1998 Rule 144A private offering. Interest is fixed at 7.5%and is due and payable in semi-annual installments, which began December 1,1998. The Senior Notes mature on June 1, 2008. The Senior Notes contain covenants placing limitations on the Company’sability to permit subsidiaries to incur certain debts, incur certain loans, andengage in certain sale and leaseback transactions. During the nine months endedSeptember 30, 2003, the Company repurchased Senior Notes with a face amount 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 ninemonths ended September 30, 2003.

 

**SubordinatedUnsecured Sponsor Note**. The Company’s Sponsor Notebears interest at 10.0%, due and payable quarterly. The Sponsor Note issubordinate only upon bankruptcy or insolvency of the Company, or if uponmaturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. TheSponsor Note matures on July 22, 2009. As provided under the agreement, however, the Sponsor Note holder, WCAS,elected to defer quarterly interest payments of $4.0 million for each of theSeptember 2000 through September 2001 quarterly periods resulting in anincrease in the principal amount of the Sponsor Note totaling $33.8 million.  Such election required a deferredfinancing-fee of 30.0% of each of the interest payments being deferred.  The Company accounts for the additionalfinancing fees as a change in the effective interest rate of the debt. WCASmay, at its election, defer each future quarterly payment under similarterms.  WCAS has not elected to deferthe quarterly payments since September 2001. In accordance with the terms of the Sponsor Note, on December 6, 2002,the Company made a $90.0 million principal payment on the Sponsor Note.  A holder of Senior Notes is contesting thispayment.  See discussion under LegalProceedings.

 

**PreferredStock – Series A**.****TheCompany allocated the proceeds from its Series A preferred stock issuance basedupon the relative fair-value of the preferred stock and warrants issued. Therelated discount is being accreted such that the carrying amount of themandatory redeemable preferred stock will equal the mandatory redemption amountat September 22, 2008. For the nine months ended September 30, 2003, accretion of the related discount and accruedbut unpaid dividends totaled $1.3 million, increasing the carrying amount to$16.1 million. As of September 30, 2003, the stated value of the Series A preferred stock, including accumulatedbut unpaid dividends, was $184.56 per share.

 

**PreferredStock – Series B**.****Forthe nine months ended September 30, 2003, the Company accrued additional unpaid dividends for its Series Bpreferred stock totaling $1.7 million, increasing the carrying amount to $10.0million.  As of September 30,2003, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $280.95 pershare.

 

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

 

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### **Contractual Obligations andCommercial Commitments.**

In the normal course of business, the Company enters into variouscontractual and other commercial commitments that impact, or could impact, theliquidity of operations. The following table outlines the commitments atSeptember 30, 2003:

 
|                               |   | **Total  Amounts** |   | **Less than****1 Year** |   | **1-3  Years** |   | **4-5****Years** |   | **Over 5  Years** |   |
|------------------------------------|--------|--------------------|--------|-------------------------|--------|----------------|--------|------------------|--------|-------------------|--------|
|                               |   | **(In Millions)**  |   |
| Long-term debt                     |   | $                  | 197.8  |                    | $      | —         |   | $                | — |              | $      | 94.0 |   | $ | 103.8 |   |
| Capital leases                     |   | 1.6                |   | 1.1                     |   | 0.5            |   | —           |   | —            |   |
| Operating  leases (non-cancelable) |   | 18.7               |   | 6.1                     |   | 6.8            |   | 5.0              |   | 0.8               |   |
| Total  Contractual                 |   | 218.1              |   | 7.2                     |   | 7.3            |   | 99.0             |   | 104.6             |   |
|                               |   |               |   |                    |   |           |   |             |   |              |   |
| Unused lines  of credit            |   | $                  | 17.1   |                    | $      | 17.1           |   | $                | — |              | $      | — |   | $ | — |   |
| Standby  letters of credit         |   | 22.8               |   | 22.8                    |   | —         |   | —           |   | —            |   |
| Total Commercial                   |   | $                  | 39.9   |                    | $      | 39.9           |   | $                | — |              | $      | — |   | $ | — |   |

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In August 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations.” SFAS No. 143 requires entities to record the fairvalue of a liability for an asset retirement obligation in the period in whichit is incurred. The Company adopted SFAS No. 143 on January 1, 2003 with noimpact to its financial position and results of operations.

 

In July 2002, the FASB issued SFAS No. 146,“Accounting for Exit or Disposal Activities”. This statement requires companies to recognize costs associated withexit or disposal activities when they are incurred rather than at the date of acommitment to an exit or disposal plan. SFAS No. 146 nullifies EITF Issue No. 94-3, “Liability Recognition forCertain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring),” and will be appliedprospectively to exit or disposal activities initiated after December 31, 2002.  The Company adopted SFAS No. 146 on January1, 2003 with no impact to the Company’s financial statements.

 

In December 2002, the FASB issued SFAS No.148, “Accounting for Stock-Based Compensation—Transition and Disclosure—anamendment of SFAS No. 123.”  Thisstatement provides alternative methods of transition for a voluntary change tothe fair-value based method of accounting for stock-based employeecompensation.  This statement alsoamends the disclosure requirements of SFAS No. 123 and APB Opinion No. 28,“Interim Financial Reporting,” to require prominent disclosures in both annualand interim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reported results.  The Company implemented SFAS No. 148 onJanuary 1, 2003, regarding disclosure requirements for condensed financialstatements for interim periods.  TheCompany has not yet determined whether it will voluntarily change to the fair-valuebased method of accounting for stock-based employee compensation.

 

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (“FIN 45”). It clarifies that a guarantoris required to recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee, including itsongoing obligation to stand ready to perform over the term of the guarantee inthe event that the specified triggering events or conditions occur. Theobjective of the initial measurement of the liability is the fair value of theguarantee at its inception. The initial recognition and initial measurementprovisions of FIN 45 are effective on a prospective basis to guarantees issuedafter December 31, 2002.  However, thedisclosure requirements are effective for interim and annualfinancial-statement periods ending after December 15, 2002. The Company hasadopted FIN 45 with no impact on the Company’s results of operations orfinancial position.

 

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In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”). FIN46 requires that unconsolidated variable-interest entities be consolidated bytheir primary beneficiaries. A primary beneficiary is the party that absorbs amajority of the entity’s expected losses or residual benefits. FIN 46 appliesimmediately to variable-interest entities created after January 31, 2003 and toexisting variable-interest entities in the periods beginning after June 15,2003.  The Company has adopted FIN 46with no effect on the Company’s results of operations or financial position.

 

In November 2002, the FASB’s Emerging Issues Task Force (“EITF”)reached a consensus on Issue 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables,” which must be applied to all revenue arrangementsentered into no later than June 30, 2003. EITF 00-21 governs how toidentify whether goods or services or both that are to be delivered separatelyin a bundled sales arrangement should be accounted for separately. Theappropriate accounting literature for revenue recognition would then be appliedto each unit.  The Company has adoptedthe consensus reached in EITF 00-21 with no impact on the Company’s results ofoperations or financial position.

 

In June 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity.” Thestatement is effective for financial instruments entered into or modified afterMay 31, 2003, and otherwise is effective at the beginning of the first interimperiod beginning after June 15, 2003, except for mandatorily redeemablefinancial instruments of a nonpublic entity. For mandatorily redeemable financial instruments of a nonpublic entity,this statement shall be effective for fiscal periods beginning after December15, 2003.  The mandatory redeemablepreferred stock issued by the Company will be reclassified to the liabilitysection of the balance sheet as required by SFAS 150 during the quarter endedMarch 31, 2004.  It is not anticipatedthat the adoption of this statement, however, will have a material effect onour results of operations.

 

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

 

There are many factors that affect the Company’s business and theresults of its operations. The following is a description of some of theimportant factors that may cause the actual results of the Company’s operationsin future periods to differ materially from those currently expected ordesired.  See “Forward LookingStatements”.

 

***General EconomicConditions***

 

The Company’s business partially depends on general economic andbusiness conditions. The Company’s sales are to businesses in a wide variety ofindustries, including banking, financial services, insurance, health care, hightechnology and governmental agencies. General economic conditions that cause customers in such industries toreduce or delay their investments in products and solutions such as thoseoffered by the Company could have a material adverse effect on the Company,including the Company’s business, operating results, financial condition, andprospects.

 

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

 

***Dependence onSuppliers***

 

The Company’s solutions products are dependent on quality 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 andImpact on Operating Results***

 

As a result of the Company’s highly leveraged position, certainnegative consequences of the Company’s indebtedness could occur, such asrestrictions on expenditures or other activities.  The Company’s future operating flexibility may be impacted.  In addition, the Company may be morevulnerable to a downturn in its operating performance or a decline in generaleconomic conditions.

 

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***InternationalActivities***

 

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

 

***Fluctuations inOperating Results***

 

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

 

***Technological Changesand 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.

 

***Product DevelopmentActivities***

 

The strength of the Company’s overall business is partially dependenton the Company’s ability to develop products and solutions based on new orevolving technology 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. The Company believes that it is necessary for itsproducts to adhere to generally accepted industry standards, which are subjectto change in ways that are beyond the control of the Company.

 

**ITEM3. QUANTITATIVE AND QUALITATIVE 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 (i) 1.50% overprime or (ii) 3.00% over LIBOR. Although noactual balances were outstanding under the Revolver at September 30, 2003,assuming $1.0 million in borrowings under the Revolver, a one hundred basispoint change in the bank’s prime or LIBOR rate would impact net interestexpense by $10,000 over a twelve-month period.

 

**ITEM4. CONTROLS AND PROCEDURES.**

 

During the audit of the Company’s 2000 financial statements, theCompany’s certifying accountant, Deloitte & Touche LLP (D&T) noted whatD&T considered to be material weaknesses in internal control design and inthe operation of internal controls.  SeeCurrent Report on Form 8-K filed with the Securities and Exchange Commission onNovember 13, 2001 for additional information regarding this item and thesubsequent change in the Company’s independent accountant.  The Company’s current independentaccountant, KPMG, LLP (KPMG), also informally noted certain internal controlweaknesses as a result of the 2001 and 2002 audits, some of which are the sameweaknesses as noted by D&T in their report.

 

The Company has addressed the individual internal control weaknessesnoted by D&T and KPMG.   Steps thathave been 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 hasbegun to put in place procedures addressing the adequacy of disclosurecontrols, including obtaining certifications from each member of managementinvolved in the preparation and review of this Form 10-Q.  The Company is continuing its efforts toevaluate and correct internal control weaknesses noted by D&T and KPMG, aswell as document the system of internal controls.  Although the Company believes that it has implemented adequatecontrols and procedures for the preparation of this report, the adequacy of theactions taken by the Company to correct certain of the previously identifiedweaknesses will not be fully known until the completion of documentation of theCompany’s system of internal controls.

 

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The Chief Executive Officer and the Chief FinancialOfficer of the Company, with the participation of the Company’s management,continue to carry out an evaluation of the effectiveness of the Company’sdisclosure controls and procedures pursuant to Exchange Act Rule13a-15(e).  Based upon the evaluationcompleted to date, the Chief Executive Officer and the Chief Financial Officerbelieve that, as of the end of the period covered by this report, the Company’sdisclosure controls and procedures are effective in making known to themmaterial information relating to the Company (including its consolidatedsubsidiaries) required to be included in this report.

 

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

 

There was no change in the Company’s internal control over financialreporting, known to the Chief Executive Officer or the Chief Financial Officer,that occurred during the period covered by this report that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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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 inthe Supreme Court of the State of New York for the County of New York naming asdefendants the Company and certain of its affiliates.  The complaintalleges that the Company improperly made a payment to the holder of the SponsorNote.  The complaint seeks damages of not less than $89 million as aresult of the alleged improper payment and the imposition of a constructivetrust on monies paid by the Company to the holder of the Sponsor Note. The Company’s $90 million payment to the holder of the Sponsor Note wasdisclosed in the Company’s Current Report on Form 8-K dated November 27,2002.  The Company and the plaintiff have each submitted a motion forsummary judgment, on which the court has not yet ruled.  The Company believes that the allegations ofthe complaint are without merit and intends to defend against them vigorously.

 

If the lawsuit were to result in a determination that the payment toreduce the principal amount of the Sponsor Note was in contravention of theterms of the Sponsor Note, a position strongly opposed bythe Company, under its terms, such payment shall be held in trust to bepaid over to the holders of the Senior Notes, to the extent they remainunpaid.  Therefore, in the event of an unfavorable outcome in thislitigation, there will be no adverse effect on the Company’s financialstatements.

 

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 SecurityHolders**

 

None

 

**ITEM 5. Other Information**

 

None

 

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

 

(a)          Exhibits:

 

10.1 – Sixth Amendment to Loan and Security Agreement,dated as of September 1, 2003, between Heller Financial, Inc. and BancTec, Inc.

 

31.1 – Certificate of Chief Executive Officerpursuant to Rule 15d-14(a) under the Securities Exchange Act

 

31.2 – Certificate of Chief Financial Officerpursuant to Rule 15d-14(a) under the Securities Exchange Act

 

32.1 – Certificateof Chief Executive Officer pursuant to 18 USC 1350 and Rule 15d-14(a) under theSarbanes-Oxley Act

 

32.2 – Certificateof Chief Financial Officer pursuant to 18 USC 1350 and Rule 15d-14(a) under theSarbanes-Oxley Act

 

(b)         Reports onForm 8-K:

 

None

 

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**SIGNATURES**

 

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

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

 

 

Dated: November 14, 2003

 

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