**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

**x**                              QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

**For the quarterly periodended June 30, 2006**

** **

**OR**

** **

**o**                                 TransitionReport 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 its charter)

 

| **DELAWARE**                                                    |   | **75-1559633**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

** **

**2701 E. Grauwyler Road,Irving, Texas 75061**

**(972) 821-4000**

(Address and telephone number of principal executiveoffices)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  x   No  o

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated  filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes  o   No  x

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.
|                                        | ** ** | Number of Shares Outstanding at | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|
| **Title of Each Class** | ** ** | **August 14, 2006**                       | ** ** |
|                                   |       |                                                |       |
| Common Stock, $0.01 par  value         |       | 17,003,838                                          |       |
| Class A Common Stock, $0.01 par value  |       | 1,181,946                                           |       |

 

 

 

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BancTec, Inc.Quarterly ReportonForm 10-QSix Months Ended June 30, 2006

TABLE OF CONTENTS

 
|          | ** **                                                                                          | ** ** |
|----------|-----------------------------------------------------------------------------------------------------|------------|
|     | PART I                                                                                              |       |
|     |                                                                                                |       |
| ITEM  1. | ***Financial  Statements (Unaudited)***                                                             |       |
|     | *** ***                                                                                        |       |
|     | Condensed Consolidated Balance Sheets: June 30, 2006  and December 31, 2005                         |       |
|     |                                                                                                |       |
|     | Condensed Consolidated Statements of Operations: Three  and Six Months Ended June 30, 2006 and 2005 |       |
|     |                                                                                                |       |
|     | Condensed Consolidated Statements of Cash Flows: Six  Months Ended June 30, 2006 and 2005           |       |
|     |                                                                                                |       |
|     | Notes to Condensed Consolidated Financial Statements                                                |       |
|     |                                                                                                |       |
| ITEM 2.  | Management’s Discussion and Analysis of Financial  Condition and Results of Operations         |       |
|     |                                                                                                |       |
| ITEM 3.  | Quantitative and Qualitative Disclosure about Market  Risk                                          |       |
|     |                                                                                                |       |
| ITEM 4.  | Controls and Procedures                                                                             |       |
|     |                                                                                                |       |
|     | PART II                                                                                             |       |
|     |                                                                                                |       |
| ITEM  1. | Legal  Proceedings                                                                                  |       |
|     |                                                                                                |       |
| ITEM 1A  | Risk Factors                                                                                        |       |
|     |                                                                                                |       |
| ITEM 2.  | Unregistered Sales of Equity Securities and Use of Proceeds                                         |       |
|     |                                                                                                |       |
| ITEM 3.  | Defaults Upon Senior Securities                                                                     |       |
|     |                                                                                                |       |
| ITEM 4.  | Submission of Matters to a Vote of Security Holders                                                 |       |
|     |                                                                                                |       |
| ITEM  5. | Other  Information                                                                                  |       |
|     |                                                                                                |       |
| ITEM 6.  | Exhibits and Reports on Form 8-K                                                                    |       |

 

 

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**PART I**

**ITEM 1. Financial Statements**

**FINANCIAL INFORMATION**

**BANCTEC, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                         | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                                                         | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                                                                                         | ** ** | **(In thousands)** | ** ** |
| CURRENT  ASSETS:                                                                                                   |       |                    |       |                  |       |
| Cash and cash equivalents                                                                                          |       | $                       | 9,350      |                  | $          | 18,540 |   |
| Restricted cash                                                                                                    |       | 1,390                   |       | 3,205                 |       |
| Accounts receivable, less allowance for doubtful accounts of $1,322 and $1,110, respectively                       |       | 63,941                  |       | 58,020                |       |
| Inventories, net                                                                                                   |       | 27,028                  |       | 19,807                |       |
| Prepaid expenses                                                                                                   |       | 8,801                   |       | 5,488                 |       |
| Other current assets                                                                                               |       | 1,067                   |       | 1,115                 |       |
| Total current assets                                                                                               |       | 111,577                 |       | 106,175               |       |
|                                                                                                               |       |                    |       |                  |       |
| PROPERTY,  PLANT AND EQUIPMENT, net                                                                                |       | 32,801                  |       | 29,924                |       |
|                                                                                                               |       |                    |       |                  |       |
| OTHER  ASSETS:                                                                                                     |       |                    |       |                  |       |
| Goodwill                                                                                                           |       | 42,052                  |       | 41,973                |       |
| Other intangible assets, less accumulated amortization of $768 and  $297, respectively                             |       | 4,844                   |       | 5,018                 |       |
| Deferred income tax benefit                                                                                        |       | 9,881                   |       | 10,336                |       |
| Other assets                                                                                                       |       | 3,593                   |       | 3,788                 |       |
| Total other assets                                                                                                 |       | 60,370                  |       | 61,115                |       |
|                                                                                                               |       |                    |       |                  |       |
| TOTAL  ASSETS                                                                                                      |       | $                       | 204,748    |                  | $          | 197,214 |   |
|                                                                                                               |       |                    |       |                  |       |
| CURRENT  LIABILITIES:                                                                                              |       |                    |       |                  |       |
| Current obligations under capital leases, financing arrangements and  revolver                                     |       | $                       | 17,996     |                  | $          | 1,095 |   |
| Trade accounts payable                                                                                             |       | 21,169                  |       | 19,870                |       |
| Other accrued expenses and liabilities                                                                             |       | 28,233                  |       | 31,293                |       |
| Deferred revenue                                                                                                   |       | 22,204                  |       | 21,505                |       |
| Maintenance contract deposits                                                                                      |       | 32,178                  |       | 33,453                |       |
| Income taxes payable                                                                                               |       | 6,689                   |       | 4,947                 |       |
| Total current liabilities                                                                                          |       | 128,469                 |       | 112,163               |       |
|                                                                                                               |       |                    |       |                  |       |
| OTHER  LIABILITIES:                                                                                                |       |                    |       |                  |       |
| Long-term debt                                                                                                     |       | 198,466                 |       | 199,063               |       |
| Non-current maintenance contract deposits                                                                          |       | 6,754                   |       | 11,466                |       |
| Pension liability                                                                                                  |       | 22,721                  |       | 22,719                |       |
| Other non-current liabilities                                                                                      |       | 6,455                   |       | 5,748                 |       |
| Total other liabilities                                                                                            |       | 234,396                 |       | 238,996               |       |
|                                                                                                               |       |                    |       |                  |       |
| Total liabilities                                                                                                  |       | 362,865                 |       | 351,159               |       |
| COMMITMENTS  AND CONTINGENCIES                                                                                     |       |                    |       |                  |       |
|                                                                                                               |       |                    |       |                  |       |
| SERIES  A PREFERRED STOCK — issued and outstanding, 100,667 shares at June 30, 2006  and December 31, 2005    |       | 18,040                  |       | 18,040                |       |
|                                                                                                               |       |                    |       |                  |       |
| STOCKHOLDERS’  DEFICIT:                                                                                       |       |                    |       |                  |       |
| Cumulative preferred stock - authorized, 200,000 shares of $0.01 par  value at June 30, 2006 and December 31, 2005 |       |                    |       |                  |       |
| Series B preferred stock - issued and outstanding, 35,520 shares at June 30, 2006 and December 31,  2005           |       | 13,520                  |       | 13,520                |       |
| Common stock authorized, 21,800,000 shares of $0.01 par value at  June 30, 2006 and December 31, 2005:             |       |                    |       |                  |       |
| Common stock-issued and outstanding 17,003,838 shares at June 30, 2006 and December 31, 2005                       |       | 170                     |       | 170                   |       |
| Class A common stock-issued and outstanding 1,181,946 shares at June 30, 2006 and December 31, 2005                |       | 12                      |       | 12                    |       |
| Subscription stock warrants                                                                                        |       | 3,726                   |       | 3,726                 |       |
| Additional paid-in capital                                                                                         |       | 122,775                 |       | 122,655               |       |
| Accumulated deficit                                                                                                |       | (300,275                | )          | (293,542              | )          |
| Accumulated other comprehensive loss                                                                               |       | (16,085                 | )          | (18,526               | )          |
| Total stockholders’ deficit                                                                                   |       | (176,157                | )          | (171,985              | )          |
|                                                                                                               |       |                    |       |                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT                                                                   |       | $                       | 204,748    |                  | $          | 197,214 |   |

 

See notes to unaudited condensedconsolidated financial statements.

3

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**
| ** **                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(In thousands)**                             | ** ** | **(In thousands)**                           | ** ** |
| REVENUE                              |       |                                                |       |                                              |       |   |   |   |   |
| Equipment and software               |       | $                                                   | 34,640     |                                              | $          | 31,399 |   | $ | 65,052 |   | $ | 65,810 |   |
| Maintenance and other services       |       | 60,486                                              |       | 53,035                                            |       | 119,752 |   | 107,259 |   |
|                                 |       | 95,126                                              |       | 84,434                                            |       | 184,804 |   | 173,069 |   |
| COST OF SALES                        |       |                                                |       |                                              |       |   |   |   |   |
| Equipment and software               |       | 19,747                                              |       | 18,591                                            |       | 37,612 |   | 38,816 |   |
| Maintenance and other services       |       | 50,353                                              |       | 44,881                                            |       | 103,287 |   | 89,080 |   |
|                                 |       | 70,100                                              |       | 63,472                                            |       | 140,899 |   | 127,896 |   |
| Gross profit                         |       | 25,026                                              |       | 20,962                                            |       | 43,905 |   | 45,173 |   |
|                                 |       |                                                |       |                                              |       |   |   |   |   |
| OPERATING EXPENSES                   |       |                                                |       |                                              |       |   |   |   |   |
| Product development                  |       | 1,693                                               |       | 2,580                                             |       | 3,455 |   | 4,831 |   |
| Selling, general and  administrative |       | 17,072                                              |       | 17,247                                            |       | 33,650 |   | 34,291 |   |
|                                 |       | 18,765                                              |       | 19,827                                            |       | 37,105 |   | 39,122 |   |
| Income from operations               |       | 6,261                                               |       | 1,135                                             |       | 6,800 |   | 6,051 |   |
|                                 |       |                                                |       |                                              |       |   |   |   |   |
| OTHER INCOME (EXPENSE)               |       |                                                |       |                                              |       |   |   |   |   |
| Interest income                      |       | 54                                                  |       | 201                                               |       | 144 |   | 428 |   |
| Interest expense                     |       | (5,048                                              | )          | (4,753                                            | )          | (9,869 | ) | (9,512 | ) |
| Sundry, net                          |       | (27                                                 | )          | (241                                              | )          | (27 | ) | (717 | ) |
|                                 |       | (5,021                                              | )          | (4,793                                            | )          | (9,752 | ) | (9,801 | ) |
| INCOME (LOSS) BEFORE INCOME TAXES    |       | 1,240                                               |       | (3,658                                            | )          | (2,952 | ) | (3,750 | ) |
| INCOME TAX EXPENSE                   |       | 2,464                                               |       | 1,330                                             |       | 3,781 |   | 2,682 |   |
| NET  LOSS                            |       | (1,224                                              | )          | (4,988                                            | )          | (6,733 | ) | (6,432 | ) |
|                                      |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

See notes to unaudited condensedconsolidated financial statements.

4

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**
| ** **                                                                 | ** ** | **Six Months Ended June 30** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                          | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES                                       |       |                                             |       |   |   |
| Net loss                                                                   |       | $                                                | (6,733     | ) | $ | (6,432 | ) |
| Adjustments to reconcile net  loss to cash flows used in operations:       |       |                                             |       |   |   |
| Depreciation and amortization                                              |       | 7,876                                            |       | 7,367 |   |
| Provision for doubtful  accounts                                           |       | 150                                              |       | (111 | ) |
| Deferred income tax expense                                                |       | 493                                              |       | 139 |   |
| Loss on disposition of  property, plant and equipment                      |       | 202                                              |       | 522 |   |
| Other non-cash items                                                       |       | 200                                              |       | 34 |   |
| Changes in operating assets  and liabilities:                              |       |                                             |       |   |   |
| Increase in accounts  receivable                                           |       | (3,885                                           | )          | (1,517 | ) |
| (Increase) decrease in  inventories                                        |       | (6,998                                           | )          | 694 |   |
| Increase in other assets                                                   |       | (2,307                                           | )          | (968 | ) |
| Increase (decrease) in trade  accounts payable                             |       | 1,001                                            |       | (692 | ) |
| Decrease in deferred revenue  & maintenance contracts deposits         |       | (5,797                                           | )          | (14,194 | ) |
| (Decrease) increase in other  accrued expenses and liabilities             |       | (3,122                                           | )          | 5,227 |   |
| Cash flows used in operating  activities                                   |       | (18,920                                          | )          | (9,931 | ) |
|                                                                       |       |                                             |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                       |       |                                             |       |   |   |
| Purchases of property, plant  and equipment                                |       | (8,876                                           | )          | (3,351 | ) |
| Decrease in restricted cash                                                |       | 1,815                                            |       | 3,629 |   |
| Purchase of intangibles                                                    |       | (79                                              | )          | — |   |
| Cash flows (used in) provided  by investing activities                     |       | (7,140                                           | )          | 278 |   |
|                                                                       |       |                                             |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                       |       |                                             |       |   |   |
| Payments of current maturities  of capital lease and financing obligations |       | (845                                             | )          | (241 | ) |
| Proceeds (payments) on  revolver, net                                      |       | 16,699                                           |       | (1 | ) |
| Debt issuance costs                                                        |       | (200                                             | )          | (70 | ) |
| Cash flows provided by (used  in) financing activities                     |       | 15,654                                           |       | (312 | ) |
|                                                                       |       |                                             |       |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                    |       | 1,216                                            |       | (951 | ) |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                  |       | (9,190                                           | )          | (10,916 | ) |
| CASH AND CASH EQUIVALENTS—BEGINNING OF PERIOD                         |       | 18,540                                           |       | 47,431 |   |
|                                                                       |       |                                             |       |   |   |
| CASH AND CASH EQUIVALENTS—END OF PERIOD                               |       | $                                                | 9,350      |   | $ | 36,515 |   |
|                                                                       |       |                                             |       |   |   |
| SUPPLEMENTAL DISCLOSURES INFORMATION:                                      |       |                                             |       |   |   |
| Cash paid during the period  for:                                          |       |                                             |       |   |   |
| Interest                                                                   |       | $                                                | 9,004      |   | $ | 8,848 |   |
|                                                                       |       |                                             |       |   |   |
| Taxes                                                                      |       | $                                                | 991        |   | $ | 973 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

5

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**BANCTEC,INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

**1.             NATURE OF BUSINESSAND BASIS OF PRESENTATION**

BancTec, Inc. is aworldwide systems integration and services company with a 30-year history inimaging technology, financial transaction processing and workflow productivityimprovement.  Serving a variety ofindustries, including banking, financial services, insurance, healthcare,governmental agencies and others, the Company offers a portfolio of payment anddocument processing systems and services, workflow and image managementsoftware products, and computer and network support services.

The accompanyingunaudited condensed consolidatedbalance sheet at June 30, 2006, and the unaudited condensed consolidated statements of operations and cash flows forthe interim periods ended June 30, 2006 and 2005, should be read in conjunctionwith BancTec, Inc. and subsidiaries (“BancTec” or the “Company”) consolidatedfinancial statements and notes thereto in the most recent Annual Report on Form10-K filed with the Securities and Exchange Commission.   In the opinion of management, theaccompanying unaudited condensedconsolidated financial statements contain all material adjustments, consistingprincipally of normal recurring adjustments, necessary for a fair presentationof the financial position and results of operations of the Company. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

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

The significantaccounting principles and practices used in the preparation of the accompanyingfinancial statements are summarized below:

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

Cash and cash equivalents include cash on hand and on deposit, includinghighly liquid investments with original maturities of three months or less.  Restricted cash at June 30, 2006 of $1.4million and at December 31, 2005 of $3.2 million represents cash in escrow froma customer deposit.

**Property, Plant, and Equipment**

Property, plant, and equipment are recorded at cost and are depreciatedor amortized on a straight-line basis over the estimated useful lives of therelated assets. Depreciation expense is reflected in both cost of sales andselling, general and administrative expense. Depreciation expense for the six months ended June 30, 2006 and 2005 was$7.4 million and $7.4 million, respectively.

**RevenueRecognition**

The Company derivesrevenue primarily from two sources: (1) equipment and software sales - systemsintegration solutions which address complex data and paper-intensive workprocesses, including advanced web-enabled imaging and workflow technologieswith both BancTec-manufactured equipmentand third-party equipment, and (2)maintenance and other services - 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’s revenuerecognition policies are in accordance with Statement of Position (“SOP”) 97-2,*“Software Revenue Recognition,”*as amended by SOP 98-9, “*Modification of SOP97-2,**Software RevenueRecognition with Respect to Certain Transactions”,*“Staff Accounting Bulletin (“SAB”) No. 101,*“Revenue Recognition in Financial Statements,”** *SABNo. 104,*“Revenue Recognition,”*Emerging Issues Task Force (“EITF”) No. 00-21,*“Revenue Arrangements with Multiple Deliverables,”*and EITF No. 03-5, *“Applicability of AICPA Statement of Position 97-2 toNon-Software Deliverables in an Arrangement Containing More-Than-IncidentalSoftware.”*

6

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*Software and software elements(including equipment, installation and training)*

In the case of softwarearrangements that require significant production, modification, orcustomization of software, or the license agreements require the Company toprovide implementation services that are determined to be essential to otherelements of the arrangement, the Company follows the guidance in SOP 81-1, *“Accounting for Performance of Construction—Type andCertain Production—Type Contracts,”*and applies the completed contract method of accounting.* *Incompliance with the completed contract method under SOP 81-1, revenue isrecognized when proof of customer acceptance has been received. * *Inthe case of non-software arrangements, the Company applies EITF No. 00-21where revenues related to arrangements with multiple elements are allocated toeach element based on the element’s relative fair value.  Revenueallocated to separate elements is recognized for each element in accordancewith the accounting policies described below. EITF No. 03-5 is applied in determining whether non-software elementsare included with the software in applying SOP 97-2.

If the Company cannotaccount for items included in a multiple-element software or non-softwarearrangement as separate units of accounting, they are combined and accountedfor as a single unit of accounting and generally recognized as the undelivereditems or services are provided to the customer. The Company specifically uses the residual method, under which revenueis recognized on the delivered elements only when the remaining undeliveredelement is postcontract customer support (PCS).

The Company recognizeshardware and software revenue when persuasive evidence of an arrangementexists, delivery has occurred, the sales price is fixed or determinable andcollectibility is reasonably assured. At the time of the transaction, theCompany determines whether the fee associated with revenue transactions isfixed or determinable and whether or not collection is reasonably assured. TheCompany determines whether the fee is fixed or determinable based on thepayment terms associated with the transaction. If a significant portion of afee is due after the normal payment terms, which are generally 30 days frominvoice date, the Company recognizes revenue as the fees are due. The Companyassesses collectibility based on a number of factors, including pasttransaction history with the customer and the credit-worthiness of thecustomer. 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.

*Non-software equipment*

The Company recognizes revenue from sales of non-software relatedequipment and supplies upon delivery and transfer of title or upon customeracceptance.

*Postcontractcustomer support*

Maintenancecontracts are primarily one year in duration and the revenue generated isgenerally recognized ratably over the term of the contract.

*Maintenance services notclassified as postcontract customer support (PCS)*

The Company’s servicesrevenue is primarily billed based on contractual rates and terms, and theCompany generally recognizes revenue as these services are performed which, insome cases, is ratably over the contract term. Certain customers advance funds prior to the performance of the services.The Company recognizes revenue related to these advances as services areperformed over time or on a “per call” basis. Certain estimates are used in recognizing revenue on a “per call” basisrelated to breakdown rates, contract types, calls related to specific contracttypes, and contract periods.  The Companyuses its best judgment to relate calls to contracts.  In addition, as actual breakdown experiencerates are compared to estimates, such estimates may change over time and willresult in adjustments to the amount of “per call” revenue.  The current and non-current portions of theseadvances are shown as Deferred Revenue or Maintenance Contract Deposits on theCondensed Consolidated Balance Sheets.

Certain costs associatedwith contract acquisition and related direct and incremental costs arecapitalized in accordance with SOP 81-1 and Technical Bulletin 90-1.  Contract acquisition costs include directincremental costs associated with contract negotiation, such as legal fees, andcosts incurred to transform customer processes and technology in direct supportof implementing the contract terms and conditions.  These costs are amortized on a pro-rata basisover the term of the contract.

7

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**Research and Development**

Research and development costs are expensed as incurred.   Research and development costs for the sixmonths ended June 30, 2006 and 2005, were $3.5 million and $4.8 millionrespectively.

**Foreign Currency Translation**

Foreign assets and liabilities are translated using the exchange rate ineffect at the balance sheet date, and results of operations are translatedusing an average rate for the period. Translation adjustments are accumulatedand reported as a component of stockholders’ deficit and comprehensive loss.Transaction gains and losses are included in results of operations in “Sundry,net”. Foreign currency transaction losses for the six months ended June 30,2006 and 2005 were $0.01 million and $0.7 million, respectively.

**AccruedVacation**

** **

The Company modified the vacation policy with regard to employees in theUnited States as of June 30, 2006.  Priorto June 30, 2006, vacation was earned and accrued as the employee worked.  A maximum of one week of unused vacationcould be carried over to the subsequent year and any earned but unused vacationwould be paid to the employee upon termination. Beginning June 30, 2006, the vacation policy was changed to provide thatvacation is provided as a company benefit, and is not earned and does notaccrue.  As a result, unused vacation isnot payable upon termination, unless specifically provided for by statelaw.  In addition, no unused vacation iseligible to be carried over to subsequent calendar years.  As a result of this change in policy, theCompany adjusted its vacation accrual to be equal to the unused vacation foremployees in those states which require vacation be paid upon termination.  Accrued vacation was $3.2 million and $2.6million at December 31, 2005 and June 30, 2006 respectively.  The impact of adjusting the vacation accrualat June 30, 2006 was $1.3 million for the three months ended June 30, 2006.

**Stock-Based Compensation**

Effective January1, 2006, the Company adopted the provisions of Statement of FinancialAccounting Standards No. 123R, (“SFAS 123R”) “Share-Based Payment,” whichestablishes accounting for equity instruments exchanged for employee services.Under the provisions of SFAS No. 123R, share-based compensation cost is measuredat the grant date, based on the calculated fair value of the award, and isrecognized as an expense over the employee’s requisite service period(generally the vesting period of the equity grant).

Prior to January1, 2006, the Company accounted for share-based compensation to employees inaccordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations. The Company alsofollowed the disclosure requirements of SFAS No. 123, “Accounting forStock-Based Compensation”, as amended by SFAS 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure”.

The Companyelected to adopt the modified prospective transition method as provided by SFASNo. 123R and, accordingly, financial statement amounts for the prior periodspresented in this Form 10-Q have not been restated to reflect the fair valuemethod of expensing share-based compensation. Under this application, theCompany is required to record compensation cost for all share-based paymentsgranted after the date of adoption based on the grant date fair value estimatedin accordance with the provisions of SFAS 123R and for the unvested portion ofall share-based payments previously granted that remain outstanding which were basedon the grant date fair value estimated in accordance with the originalprovisions of SFAS 123.

Effective July 1, 2000, the Company adopted the 2000 Stock Plan (thePlan), which provides for the grant to employees of incentive options,non-qualified stock options, and restricted stock awards.

*Incentive Options.*During the year ended December 31, 2005, the Company granted 640,000 incentiveoptions.  During the six months endedJune 30, 2006, 240,000 incentive options were granted.  Under the Plan, incentive options are grantedat a fixed exercise price not less than 100% of the fair market value of theshares of stock on the date of grant (or not less than 110% of the fair marketvalue in certain circumstances).  Optionsgranted in 2005 and 2006 vest over a four-year period at 25% per year.

*Non-qualified stock options.* No non-qualified stock options were granted during the year endedDecember 31, 2005 or the six months ended June 30, 2006.  When granted 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.

8

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At December 30, 2005, with board of directors’ approval, all stockoptions were repriced from a previous strike price of $9.25 to a strike priceof $2.25.  No other provisions of thestock options were modified.

A combined summary of activity, including restricted stock awards in the2000 Stock Plan during the three months and six months ended June 30, 2006 isas follows:

 
| ** **                               | ** ** | **Incentive  Shares** | ** ** | **Non-qualified  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|------------------------------------------|------------|-----------------------|------------|---------------------------|------------|----------------------------------------|------------|---------------------------------------------------------|------------|
| Options outstanding—January 1, 2006 |       | 2,343,740             |       | 31,760                    |       | 2.25                                   |       | .44                                                     |       |   |
| Granted                                  |       | 240,000               |       | —                    |       | 2.25                                   |       | .44                                                     |       |   |
| Forfeited                                |       | —                |       | —                    |       | 2.25                                   |       | .44                                                     |       |   |
| Exercised                                |       | —                |       | —                    |       |                                   |       |                                                    |       |   |
| Options outstanding—March 31, 2006  |       | 2,583,740             |       | 31,760                    |       | 2.25                                   |       | .44                                                     |       |   |
| Granted                                  |       | —                |       | —                    |       | 2.25                                   |       | .44                                                     |       |   |
| Forfeited                                |       | (50,000               | )          | —                    |       |                                   |       |                                                    |       |   |
| Exercised                                |       | —                |       | —                    |       |                                   |       |                                                    |       |   |
| Options  outstanding—June 30, 2006  |       | 2,533,740             |       | 31,760                    |       | 2.25                                   |       | .44                                                     |       |   |
|                                          |            |                       |            |                           |            |                                        |            |                                                         |            |  |  |

 

Options and awards expire and terminate the earlier of 10 years from thedate of grant or three months after the date the employee ceases to be employedby the Company.  The weighted averageremaining contractual life of the outstanding options at June 30, 2006 is 8.06years, 8.13 years, 8.25 years at June 30, 2006, March 31, 2006, and December31, 2005, respectively.

The following table presents the vested status of all options outstandingat June 30, 2006:

 
| ** **                                                                     | ** ** | **December 31,  2005** | ** ** | **March 31,  2006** | ** ** | **June 30,  2006** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|-------------------------|------------|
| Total options outstanding                                                      |       | 2,375,500                   |       | 2,615,500                |       | 2,565,500               |       |
| Vested Options                                                                 |       | 560,975                     |       | 682,100                  |       | 784,600                 |       |
| Nonvested options                                                              |       | 1,814,525                   |       | 1,933,400                |       | 1,780,900               |       |
| Compensation related to nonvested options                                      |       | $                           | 637        |                     | $          | 639                     |       | $ | 596 |   |
| Weighted-average  period over which remaining compensation is to be recognized |       | 2.6 years                   |       | 2.8 years                |       | 2.4 years               |       |
|                                                                                |            |                             |            |                          |            |                         |            |  |  |  |

 

The followingtable presents share-based compensation expenses for continuing operationsincluded in the Company’s unaudited condensed consolidated statements ofoperations:

|                                                                                                              | ** ** | **Three Months  Ended  June 30, 2006** | ** ** | **Six Months  Ended  June 30, 2006** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Share-based  compensation expense recorded as selling, general and administrative, net of  tax benefit of $0 |       | $                                                     | (60        | )                                                   | $          | (120 | ) |
|                                                                                                              |            |                                                       |            |                                                     |            |  |  |

 

The Company hadpreviously adopted the provisions of Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), asamended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transitionand Disclosure” through disclosure only. Under the intrinsic-value method,compensation expense is recorded only to the extent that the strike price isless than fair value on the measurement date. All options granted in 2005 were issued at or above fair value, andtherefore no stock-based compensation was recorded.  In addition, at December 30, 2005, when theoptions were repriced, creating variable plan accounting, no 

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stock-based compensation was recorded in accordance with APB 25, as therepriced options had no intrinsic value on the date of the change.  As of December 31, 2005, the options had nointrinsic value.

The followingtable illustrates the effects on net income for the three and six months endedJune 30, 2005 as if the Company had applied the fair value recognition provisionsof SFAS 123 to share-based employee awards.
| ** **                                                                                                                           | ** ** | **Three Months  Ended  June 30, 2005** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Net loss applicable to common stock, as reported                                                                                     |       | $                                                     | (4,988     | )                                                   | $          | (6,432 | ) |
| Total stock-based  employee compensation expense determined under fair-value-based  method for all rewards, net of tax benefit of $0 |       | (14                                                   | )          | (28                                                 | )          |
| Pro Forma net loss                                                                                                                   |       | $                                                     | (5,002     | )                                                   | $          | (6,460 | ) |

 

The fair value of each stock-option grant under the stock option planswas estimated on the date of grant using the Black-Scholes option-pricingmodel.  The fair value of eachstock-option grant was estimated with the following weighted-averageassumptions and results:
| ** **                     | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **Weighted Average**      | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Risk free interest rate        |       | 4.5                                                 | %          | 4.6                                               | %          | 4.5 | % | 4.6 | % |
| Expected life                  |       | 10  years                                           |       | 10  years                                         |       | 10  years |   | 10  years |   |
| Expected volatility            |       | 40.0                                                | %          | 40.0                                              | %          | 40.0 | % | 40.0 | % |
| Dividend yield                 |       | —                                              |       | —                                            |       | — |   | — |   |
| Fair  value of options granted |       | $                                                   | 0.44       |                                              | $          | 0.12 |   | $ | 0.44 |   | $ | 0.12 |   |
|                                |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

**3.****                                      RECLASSIFICATION**

Certain amountshave been reclassified from the prior years to conform to the current yearpresentation.

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

The Consolidated Statement of Cash Flows included the following noncashinvesting and financing transactions:

|                                                                   | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                                        | ** ** | **(In thousands)**                           | ** ** |
| Capital lease  obligation incurred for lease of computer hardware |       | $                                                 | 1,159      |   | $ | — |   |
| Inventory put in  service as fixed asset                          |       | —                                            |       | 1,537 |   |
|                                                                   |            |                                                   |            |  |  |  |  |

 

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**5.**             **INVENTORIES**

Inventory consists of the following:

|                         | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **              | ** ** | **(In thousands)** | ** ** |
| Raw materials           |       | $                       | 10,414     |                  | $          | 9,503 |   |
| Work-in-progress        |       | 6,394                   |       | 3,305                 |       |
| Finished goods          |       | 23,693                  |       | 19,550                |       |
|                    |       | 40,501                  |       | 32,358                |       |
| Less inventory reserves |       | (13,473                 | )          | (12,551               | )          |
| Inventories,  net       |       | $                       | 27,028     |                  | $          | 19,807 |   |

 

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

Property, plant and equipment consist of the following:

|                                           | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                | ** ** | **(In thousands)** | ** ** |
| Land                                      |       | $                       | 874        |                  | $          | 874 |   |
| Field support spare parts                 |       | 36,208                  |       | 34,853                |       |
| Systems and software                      |       | 52,809                  |       | 52,263                |       |
| Machinery and equipment                   |       | 22,376                  |       | 21,094                |       |
| Furniture, fixtures and other             |       | 10,158                  |       | 9,573                 |       |
| Buildings                                 |       | 20,747                  |       | 20,716                |       |
| Construction in process                   |       | 12,613                  |       | 5,483                 |       |
|                                      |       | 155,785                 |       | 144,856               |       |
| Accumulated depreciation and amortization |       | (122,984                | )          | (114,932              | )          |
| Property,  plant and equipment, net       |       | $                       | 32,801     |                  | $          | 29,924 |   |

 

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**7.**                                      **OTHER ACCRUED EXPENSES ANDLIABILITIES**

Other accrued expenses and liabilities consist of the following:

|                                        | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                             | ** ** | **(In thousands)** | ** ** |
| Salaries, wages and other compensation |       | $                       | 8,511      |                  | $          | 11,903 |   |
| Accrued taxes, other than income taxes |       | 4,146                   |       | 4,376                 |       |
| Accrued interest payable               |       | 3,355                   |       | 3,200                 |       |
| Accrued invoices and costs             |       | 1,937                   |       | 1,586                 |       |
| Other                                  |       | 10,284                  |       | 10,228                |       |
|                                   |       | $                       | 28,233     |                  | $          | 31,293 |   |

 

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

Debt and other obligations consist of the following:

|                                                       | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                            | ** ** | **(In thousands)** | ** ** |
| Senior Notes, due 2008                                |       | $                       | 93,975     |                  | $          | 93,975 |   |
| Revolving Credit Facility                             |       | 16,700                  |       | 1                     |       |
| Senior Subordinated Sponsor Note, unsecured, due 2009 |       | 103,848                 |       | 103,848               |       |
| Financing Arrangement                                 |       | 1,239                   |       | 1,860                 |       |
|                                                  |       | 215,762                 |       | 199,684               |       |
| Less: Current portion                                 |       | 17,296                  |       | 621                   |       |
|                                                  |       | $                       | 198,466    |                  | $          | 199,063 |   |

 

Revolving CreditFacility.****The Company has a revolving credit facility (the “Revolver”)provided by Heller Financial, Inc. (“Heller”). Effective March 31, 2006, the Company and Heller entered into anamendment to the Revolver which extended the maturity date from May 30, 2006 toMay 1, 2008.  The committed amount is $40 million,with a letter-of-credit sub-limit of $10 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.  Fundsavailability under the Revolver is determined by a borrowing-base formula equalto a specified percentage of the value of the Company’s eligible accountsreceivable (including accounts receivable of certain foreign subsidiaries),inventory, owned real property, machinery and equipment and pledged cash.  Under this borrowing-base formula, the totalavailability at June 30, 2006 was $34.0 million.  At June 30, 2006, the Company had $16.7million outstanding under the Revolver and no outstanding balance onletters-of-credit.  The availabilityremaining under the Revolver that the Company can draw was $17.3 million atJune 30, 2006.  A commitment fee of0.375% per annum on the unused portion of the Revolver is payable quarterly.

The interest rate onborrowings under the Revolver is, at the Company’s option, either (1) 0.25%over prime or (2) 1.75% over LIBOR.  AtJune 30, 2006, the Company’s weighted average rate on the Revolver was 7.3%.

The Revolver containsrestrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. The Revolver contains various representations, warranties and covenants,including financial covenants as to minimum fixed charge coverage ratio andminimum average borrowing availability. Effective March 31, 2006, the Company and Heller amended the loan andsecurity agreement to state that a covenant to maintain a specified fixedcharge coverage ratio would apply only if the average daily availability forthe three 

 

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month period ending onthe last day of the most recent calendar quarter is less than $15.0million.  At June 30, 2006, the Companywas in compliance with all covenants under the Revolver.

SeniorNotes.  The Company’s Senior Notes (the “Senior Notes”)accrue interest at a fixed 7.5% rate which is due and payable in semi-annualinstallments. The Senior Notes contain covenants placing limitations on theCompany’s ability to permit subsidiaries to incur certain debts, incur certainloans and liens, and engage in certain sale and leaseback transactions.   At June 30, 2006, the Company was incompliance with all covenants under the Senior Notes.

Senior SubordinatedUnsecured Sponsor Note. The Company’s $160.0 million SponsorNote, payable to Welsh, Carson, Anderson & Stowe (“WCAS”), the majorityshareholder of the Company, bears interest at 10.0%, due and payablequarterly.  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 Sponsor Note matures on July 22,2009.  WCAS may, at its election, defereach future quarterly payment under similar terms. WCAS has elected not todefer the quarterly payments since September 2001 and currently does not intendto elect deferral of the quarterly payments in the near future.

Financing Arrangements.  During 2005, the Company entered into afinancing arrangement for $2.1 million that pertained to computer software.  At June 30, 2006, the Company had financingarrangement balances outstanding of $1.2 million, of which $0.6 million wasclassified as current and $0.6 million was classified as long-term.  This arrangement accrues interest at a fixed8.0% rate.  This arrangement is due inthree annual installments of $0.7 million, which began January 2006.

Capital Leases.  During the first six months of 2006, theCompany entered into capital leases for $1.1 million that pertained to computerhardware.  During 2005, the Companyentered into a capital lease for $1.2 million that pertained to computerhardware.  Amounts due under capitalleases are recorded as liabilities.  TheCompany’s interest in assets acquired under capital leases is recorded asproperty and equipment on the accompanying condensed consolidated financialstatements.  The gross amount of assetsheld under capital lease were $2.7 million and $1.5 million as of June 30, 2006and December 31, 2005, respectively. Amortization of assets recorded under capital leases is included indepreciation expense.  The currentobligations under capital leases are classified in the Current Liabilitiessection of the accompanying unaudited condensed consolidated balance sheets andthe non-current portion of capital leases are included in OtherLiabilities.  At June 30, 2006, theCompany had capital lease balances outstanding of $2.1 million, of which $0.7million was classified as current and $1.4 million was classified as long-term.

TheCompany had no outstanding foreign-credit borrowings as of June 30, 2006.

**9.****                                      INTANGIBLEASSETS**

The Companyaccounts for goodwill in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”.  Goodwill is not amortized but rather istested at least annually for impairment. The impairment test is based on fairvalue compared to the recorded value at a reporting unit level. Reporting unitsare defined as an operating segment or one level below. Valuation methods usedin determining fair value include an analysis of the cash flows that thereporting units can be expected to generate in the future (“Income Approach”)and the fair value of a reporting unit as compared to similar publicly tradedcompanies (“Market Approach”). In preparing these valuations, managementutilizes estimates to determine fair value of the reporting units. Theseestimates include future cash flows, growth rates, capital needs and projectedmargins, among other factors.  Estimatesutilized in future calculations could differ from estimates used in the currentperiod. Future years’ estimates that are unfavorable compared to currentestimates could cause an impairment of goodwill.  The Company performs the annual test forimpairment as of December 31, each year.

Components of theCompany’s goodwill and other intangibles include amounts that are foreigncurrency denominated.  These goodwillamounts are subject to translation at each balance sheet date.  The Company records the change to itsAccumulated Other Comprehensive Loss on the accompanying condensed consolidatedbalance sheet.

 

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**10.****                               PENSIONBENEFITS**

Net periodic pensioncosts included the following components for the three and six months ended June30:
| ** **                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                             | ** ** | **(In thousands)**                           | ** ** |
| Components  of net periodic benefits cost: |       |                                                |       |                                              |       |   |   |   |   |
| Service cost                               |       | $                                                   | 223        |                                              | $          | 103 |   | $ | 417 |   | $ | 201 |   |
| Interest cost                              |       | 476                                                 |       | 366                                               |       | 889 |   | 715 |   |
| Expected return on plan assets             |       | (272                                                | )          | (253                                              | )          | (508 | ) | (494 | ) |
| Recognized actuarial loss                  |       | 163                                                 |       | 100                                               |       | 304 |   | 195 |   |
|                                       |       |                                                |       |                                              |       |   |   |   |   |
| Net  periodic benefit cost                 |       | $                                                   | 590        |                                              | $          | 316 |   | $ | 1,102 |   | $ | 617 |   |

 

**11.**                               **TAXES**

The Company’s provisionfor income taxes for the six months ended June 30, 2006 and 2005 was$3.8 million and $2.7 million, respectively, reflecting an effectivetax rate of (126.7)% and (71.1)%, respectively. The effective tax rate differsfrom the statutory rate primarily due to the impact of different effectiverates in some overseas jurisdictions and the impact of changes in the valuationallowance on net deferred tax assets.

A valuation allowance has been provided to reduce the deferred tax assetsto an amount management believes is more likely than not to be realized.Expected realization of deferred tax assets for which a valuation allowance hasnot been recognized is based upon the reversal of existing taxable temporarydifferences and taxable income expected to be generated in the future.  The need for a valuation allowance ondeferred tax assets is evaluated on a jurisdiction by jurisdiction basis.  As a result, certain of the foreign subsidiariesdeferred tax assets are not reserved with a valuation allowance due to theirhistory of profitability.

Components of thevaluation allowance are as follows:

|                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(In thousands)**                           | ** ** |
| Valuation allowance at  beginning of year |       | $                                                 | 78,832     |   | $ | 76,184 |   |
| Release of valuation  allowance           |       | (210                                              | )          | (167 | ) |
| Loss from continuing  operations          |       | 3,722                                             |       | 3,856 |   |
| Valuation allowance at end of period      |       | $                                                 | 82,344     |   | $ | 79,873 |   |

 

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** **

**COMPREHENSIVE LOSS**

The components ofcomprehensive income (loss) were as follows:
| ** **                                | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                | ** ** | **(In thousands)**                             | ** ** | **(In thousands)**                           | ** ** |
| Net loss                                  |       | $                                                   | (1,224     | )                                                 | $          | (4,988 | ) | $ | (6,733 | ) | $ | (6,432 | ) |
| Foreign currency  translation adjustments |       | 2,239                                               |       | (964                                              | )          | 2,441 |   | (1,270 | ) |
| Total comprehensive  income (loss)        |       | $                                                   | 1,015      |                                              | $          | (5,952 | ) | $ | (4,292 | ) | $ | (7,702 | ) |

 

**12.**                               **BUSINESS SEGMENT DATA**

In 2006 and 2005, the Companyreported its operations as three primary segments: 1) Americas, 2) Europe,Middle East and Asia (“EMEA”), and 3) Information Technology Service Management(“ITSM”).

*Americasand Europe, Middle East and Asia.*  Americas and EMEA offer similarsystems-integration and business-process solutions and services and market tosimilar types of customers.  Thesolutions offered primarily involve high-volume transaction processing usingadvanced technologies that capture, process and archive paper and electronicdocuments.

*Information Technology Service Management.*  ITSM providesquality integrated support services to the evolving Information Technologyindustry, with focused deployment and ongoing support solutions for the OEM,Enterprise and Fortune marketplaces. ITSM provides coverage in North America and Europe, and customersinclude OEM providers, defense and aerospace companies, strategic outsourcingorganizations, and consumer electronics manufacturers.
| ** **                                | ** ** | **Americas**            | ** ** | **ITSM** | ** ** | **EMEA** | ** ** | **Corp/Elims** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| ** **                                | ** ** | **(In thousands)** | ** ** |
| For  the three months ended June 30, 2006 |       |                    |       |     |       |     |       |           |       |      |       |
|                                      |       |                    |       |     |       |     |       |           |       |      |       |
| Revenue  from external customers          |       | $                       | 34,231     |     | $          | 31,146   |       | $              | 29,749     |      | $          | — |   | $ | 95,126 |   |
| Intersegment  revenue                     |       | 1,324                   |       | 51       |       | 2,356    |       | (3,731         | )          | —    |       |
| Segment  gross profits                    |       | 10,030                  |       | 3,650    |       | 11,136   |       | 210            |       | 25,026    |       |
| Segment  operating income (loss)          |       | 5,383                   |       | 2,252    |       | 4,585    |       | (5,959         | )          | 6,261     |       |
|                                      |       |                    |       |     |       |     |       |           |       |      |       |
| For  the three months ended June 30, 2005 |       |                    |       |     |       |     |       |           |       |      |       |
|                                      |       |                    |       |     |       |     |       |           |       |      |       |
| Revenue  from external customers          |       | $                       | 26,925     |     | $          | 30,176   |       | $              | 27,333     |      | $          | — |   | $ | 84,434 |   |
| Intersegment  revenue                     |       | 933                     |       | —   |       | 1,771    |       | (2,704         | )          | —    |       |
| Segment  gross profits                    |       | 8,596                   |       | 1,903    |       | 10,491   |       | (28            | )          | 20,962    |       |
| Segment operating income (loss)           |       | 2,893                   |       | 624      |       | 3,844    |       | (6,226         | )          | 1,135     |       |

 

15

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| ** **                              | ** ** | **Americas**            | ** ** | **ITSM** | ** ** | **EMEA** | ** ** | **Corp/Elims** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| ** **                              | ** ** | **(In thousands)** | ** ** |
| For  the six months ended June 30, 2006 |       |                    |       |     |       |     |       |           |       |      |       |
|                                    |       |                    |       |     |       |     |       |           |       |      |       |
| Revenue  from external customers        |       | $                       | 65,775     |     | $          | 62,667   |       | $              | 56,362     |      | $          | — |   | $ | 184,804 |   |
| Intersegment  revenue                   |       | 2,382                   |       | 80       |       | 5,717    |       | (8,179         | )          | —    |       |
| Segment  gross profits                  |       | 18,474                  |       | 4,693    |       | 21,080   |       | (342           | )          | 43,905    |       |
| Segment  operating income (loss)        |       | 9,051                   |       | 1,607    |       | 8,402    |       | (12,260        | )          | 6,800     |       |
| Segment  identifiable assets            |       | 92,958                  |       | 30,677   |       | 52,077   |       | 29,036         |       | 204,748   |       |
| Capital  appropriations                 |       | 2,616                   |       | 1,614    |       | 936      |       | 4,866          |       | 10,032    |       |
|                                    |       |                    |       |     |       |     |       |           |       |      |       |
| For  the six months ended June 30, 2005 |       |                    |       |     |       |     |       |           |       |      |       |
|                                    |       |                    |       |     |       |     |       |           |       |      |       |
| Revenue  from external customers        |       | $                       | 56,644     |     | $          | 61,332   |       | $              | 55,093     |      | $          | — |   | $ | 173,069 |   |
| Intersegment  revenue                   |       | 2,088                   |       | —   |       | 3,962    |       | (6,050         | )          | —    |       |
| Segment  gross profits                  |       | 18,527                  |       | 5,480    |       | 21,205   |       | (39            | )          | 45,173    |       |
| Segment  operating income (loss)        |       | 7,536                   |       | 2,687    |       | 7,678    |       | (11,850        | )          | 6,051     |       |
| Segment  identifiable assets            |       | 78,208                  |       | 27,792   |       | 43,037   |       | 46,467         |       | 195,504   |       |
| Capital appropriations                  |       | 2,044                   |       | 759      |       | 812      |       | 1,276          |       | 4,891     |       |

 

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** **

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS.**

THEFOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS AND THE RELATED NOTES THAT APPEAR ELSEWHERE IN THISDOCUMENT.

**FORWARD-LOOKING STATEMENTS**

*This Quarterly Report on Form10-Q, including Management’s Discussion and Analysis of Financial Condition andResults of Operations and Quantitative and Qualitative Disclosure About MarketRisk contains forward-looking statements as that term is defined in the PrivateSecurities Litigation Reform Act of 1995 (the “PSLRA”) that involve risks anduncertainties, as well as assumptions that, if they never materialize or proveincorrect, could cause the results of BancTec, Inc. and its consolidatedsubsidiaries (the “Company”) to differ materially from those expressed orimplied by such forward-looking statements. All statements other than statementsof historical fact are statements that could be deemed forward-lookingstatements, including any projections of earnings, revenues, or other financialitems; any statements of the plans, strategies, and objectives of managementfor future operations; any statements concerning proposed new products,services, or developments; any statements regarding future economic conditionsor performance; statements of belief and any statement of assumptionsunderlying any of the foregoing. The risks, uncertainties and assumptionsreferred to above include the ability of the Company to retain and motivate keyemployees; the timely development, production and acceptance of products andservices and their feature sets; the challenge of managing asset levels, includinginventory; the flow of products into third-party distribution channels; thedifficulty of keeping expense growth at modest levels while increasingrevenues; and other risks that are described from time to time in the Company’sSecurities and Exchange Commission reports, including but not limited to theitems discussed in “Factors Affecting the Company’s Business and Prospects” setforth in this report, and items described in the Company’s other filings withthe Securities and Exchange Commission. The Company undertakes no obligation toupdate or revise forward-looking statements to reflect changes in assumptions,the occurrence of unanticipated results or changes to future operating resultsover time.*

**Overview**

The Company believes several factors continued to create a challengingand competitive sales and cost-containment environmentduring the six months ended June 30, 2006. These factors include: ongoing competitive pressures; the ongoingplanned change in revenue mix within the Company’s Americas and EMEA segments;and a highly leveraged financial position. The change in revenue mix is partially a result of trends in paymentprocessing, including truncation, which impacts domestic and internationalmarkets.  Additionally, during the sixmonths ended June 30, 2006, the EMEA and ITSM segments experienced revenuedeclines in the maintenance business, the duration of which the Company cannotpredict.

 

Expected economic and business conditions for the remainder of 2006indicate a cautious outlook regarding the Company’s near-term revenue andearnings growth prospects.  Many of theCompany’s product offerings represent a significant capital expenditure for itscustomers.  General economic conditionsand the impact of check truncation have caused a continued weakening in demandfor payment and check solutions products offered in North America. The Companycontinues to introduce new product offerings in its Electronic ContentManagement (“ECM”) solutions as well as the continued expansion of its managed services business into North America.   Product-development efforts are focused onECM and managed service solutions. By incorporating more third-party productsinto the Company’s solutions rather than developing the products, the Companycan more easily target its efforts and expenditures to these core products andsolutions.   In addition, the Companycontinues to seek reductions in operating costs.

** **

**RESULTS OFOPERATIONS**

**Comparisonof Three Months Ended June 30, 2006 and 2005**

Consolidatedrevenue of $95.1 million for the three months ended June 30, 2006 increased by$10.7 million or 12.7% from the comparable prior-year period.

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·                  The Americas revenue increase of $7.3 millionover the prior-year period was primarily due to the start of managed servicesin the United States and strong sales of equipment into South America.  In addition, hardware maintenance revenueincreased $1.5 million due to the addition of contracts related to themaintenance of third-party equipment. These increases were partially offset by a decline in revenues relatedto the sale and installation of packaged solutions, as the demand for paymentssolutions continues to decline due to market trends, including reduced checkvolume, check truncation, and the passage of Check 21.

·                  Revenue increases in EMEA of $2.4 million are theresult strong sales in Europe of ECM solutions and the continued growth in theUnited Kingdom of managed services, as well as the impact of a weakening dollaron the conversion of revenue stated in foreign currencies.  These increases were somewhat offset,however, by continued decreases in maintenance revenue resulting from declinesin the installed base of hardware and software.

·                  An increase in ITSM of $1.0 million resulted fromincreased revenue from the expansion by ITSM of operations in Europe, offset bydecreased revenue in the United States resulting from pricing decreases,domestic competitive pressure, and decreased volume under certain maintenanceprograms.

Factorsexpected to impact future revenue include changes in corporate-customerspending for large systems-solutions, the continued impacts of checktruncation, on-going competitive pressures, and fluctuations in internationalcurrencies.

Consolidatedgross profit of $25.0 million for the three months ended June 30, 2006, increasedby $4.1 million or 19.5% from the comparable prior-year period.

·                  Gross profit in Americas increased by $1.4million or 16.3%.  This increase was theresult of increased revenue in Americas. The Americas gross profit percentage, however, decreased from 30.9% to26.9%.  The start-up nature of theCompany’s managed services business contributed to the reduction in the America’sgross profit percentage relative to the amount of revenue generated.

·                  Increases in EMEA gross profit of $0.6 million or 5.7% also resulted from increasedrevenue, including the impact of currency conversion.  This was somewhat offset by a decline in thegross profit margin from 36.1% to 34.7%. This decrease in gross profit margin is primarily a result of productmix.  The gross profit margin for EMEA onmanaged services is slightly lower than for product sales.

·                  ITSM’s gross profit increased by $1.7 million or89.5%.   In addition to increasedrevenue, the gross profit percentage increased from 6.3% to 11.7%, due to costcontainment in the domestic operations.  ITSMis the major component in the maintenance and other services category on theCondensed Consolidated Statements of Operations, and therefore is a significantcontributing factor in the increased gross profit in the maintenance and otherservices category.

Operatingexpenses of $18.8 million decreased $1.1 million for the three months endedJune 30, 2006, compared to the prior-year period.  Product-development expenses decreased by$0.9 million or 34.6% primarily due to the timing of research projects and theuse of product development staff on customer projects.  Selling, general and administrative expenses(“SG&A”) decreased by $0.2 million or 1.2% primarily due to decreasesin marketing and sales expenses caused by reduced headcount when compared withthe prior year period.

Interestexpense for the three months ended June 30, 2006 of $5.0 millionincreased $0.2 million as compared to the prior-year period, as a result ofincreased levels of borrowing under the Revolver.

Sundry items did notsignificantly impact the results for the three months ended June 30, 2006,compared to a net loss of $0.2 million, in the comparable prior-yearperiod.  Foreign exchange transactionlosses were negligible for the three months ended June 30, 2006, and were theprimary cause of the net loss for the comparable prior year period.

An income tax provisionof $2.5 million for the three months ended June 30, 2006 is compared to a corresponding prior-year period income taxprovision of $1.3 million.  The incometax provision for both periods related primarily to income from the Company’sinternational subsidiaries.  The Company’seffective tax rate was approximately 208.3% for the three months ended June 30, 2006 as compared to (35.1%) for thecorresponding prior-year period.

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** **

**Comparisonof Six Months Ended June 30, 2006 and 2005**

Consolidatedrevenue of $184.8 million for the six months ended June 30, 2006 increased by$11.7 million or 6.8% from the comparable prior-year period.

·                  The Americas revenue increase of $9.1 million wasprimarily due to the start of managed services in the United States and strongsales of equipment into South America. In addition, hardware maintenance revenue increased $1.5 million due tothe addition of contracts related to the maintenance of third-partyequipment.  These increases werepartially offset by a decline in revenues related to the sale and installationof packaged solutions, as the demand for payments solutions continues todecline due to market trends, including reduced check volume, check truncation,and the passage of Check 21.

·                  Increases in EMEA of $1.3 million are the resultstrong sales in Europe of ECM solutions and the continued growth in the UnitedKingdom of managed services, as well as the impact of a weakening dollar on theconversion of revenue stated in foreign currencies.  These increases were somewhat offset,however, by continued decreases in maintenance revenue resulting from declinesin the installed base of hardware and software.

·                  An increase in ITSM of $1.3 million resulted fromincreased revenue from the expansion by ITSM of operations in Europe, offset bydecreased revenue in the United States resulting from pricing decreases,domestic competitive pressure, and decreased volume under certain maintenanceprograms.

Factorsexpected to impact future revenue include changes in corporate-customerspending for large systems-solutions, the continued impacts of checktruncation, on-going competitive pressures, and fluctuations in internationalcurrencies.

Consolidatedgross profit of $43.9 million for the six months ended June 30, 2006, decreasedby $1.3 million or 2.9% from the comparable prior-year period.

·                  Gross profit increased for Americas by $0.1million or 0.5%.  Although revenueincreased in Americas, the impact to gross profit was offset by a decrease inthe Americas gross profit percentage from 31.5% to 27.1%.  The start-up nature of the Company’s managedservices business contributed to the reduction in the America’s gross profitpercentage relative to the amount of revenue generated.

·                  Decreases in EMEA gross profit of $0.1 million or 0.5% resulted from a decline in thegross profit margin from 35.9% to 34.0%. Although revenue increased for theperiod, the decrease in gross profit margin resulted from a change in productmix.  The gross profit margin for EMEA onmanaged services is slightly lower than for product sales.

·                  ITSM’s gross profit decreased $0.8 million or14.5%.  A decrease in the gross marginpercentage from 9.0% to 7.5%, due to higher expenses in the domestic operationsin the first quarter of 2006 that did not match decreases in domestic revenue,more than offset the increased revenue.  ITSMis the major component in the maintenance and other services category on theCondensed Consolidated Statements of Operations, and therefore is a significantcontributing factor in the decreased gross profit in the maintenance and otherservices category.

Operatingexpenses of $37.1 million for the six months ended June 30, 2006, decreased$2.0 million compared to the prior-year period. Product-development expenses decreased by $1.4 million or 29.2%primarily due to the timing of research projects and the use of productdevelopment staff on customer projects. Selling, general and administrative expenses (“SG&A”) decreased by$0.6 million or 1.7% primarily due to decreases in marketing and salesexpenses caused by decreased headcount when compared with the prior yearperiod.

Interestexpense for the six months ended June 30, 2006 of $9.9 millionincreased $0.4 from the comparable prior-year period due to increasedborrowings on the Revolver.

Sundry items did notsignificantly impact the results for the six months ended June 30, 2006,compared to a net expense of $0.7 million, in the comparable prior-yearperiod.  Foreign exchange transactionlosses were negligible for the six months ended June 30, 2006, and were theprimary cause of the net expense for the comparable prior year period.

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An income tax provisionof $3.8 million for the six months ended June 30, 2006 is compared to a corresponding prior-year period income taxprovision of $2.7 million.  The incometax provision for both periods related primarily to income from the Company’sinternational subsidiaries.  The Company’seffective tax rate was approximately (126.7%) for the six months ended June 30, 2006 as compared to (71.1%) for thecorresponding prior-year period.

**LIQUIDITYAND CAPITAL RESOURCES**

The Company’s workingcapital requirements are generally provided by cash and cash equivalents, and fundsavailable under the Company’s revolving credit facility which matures May 1,2008.  Funds availability under therevolving credit facility is determined by a borrowing-base formula equal to aspecified percentage of the value of the Company’s eligible accounts receivable(including accounts receivable of certain foreign subsidiaries), inventory,owned real property, machinery and equipment and pledged cash.

As a result of theCompany’s high debt to equity ratio, the Company is required to devotesignificant cash to debt service.   Thislimits the Company’s future operating flexibility and could make the Companymore vulnerable to a downturn in its operating performance or a decline ingeneral economic conditions.  Such adecline in operating performance, decreased revenues from the Company’smaintenance contracts, and the requirement to obtain performance bonds orsimilar instruments could have a material impact on the Company’s futureliquidity.  The Company believes thatcash from available borrowings under its revolving credit facility and othersources of funding, will be sufficient to fund its operations for at least thenext 12 months.

TheCompany’s cash and cash equivalents totaled $9.4 million at June 30,2006, compared with $18.5 million atDecember 31, 2005.  Working capitaldecreased $10.9 million during the six months ended June 30, 2006 to a working capital deficit of $16.9 millioncompared to a working capital deficit of $6.0 million at December 31,2005.  The change in working capitalresulting from the decrease in cash of $11.0 million, an increase in currentdebt obligations of $16.9 million and an increase in accounts payable of $1.3million, some what offset by a $0.5 million decrease in deferred revenue and currentmaintenance contract deposits, a decrease in accrued liabilities of $1.3million, an accounts receivable increase of $5.9 million, an inventory increaseof $7.2 million and a prepaid expense increase of $3.3 million.

Duringthe six months ended June 30, 2006,the Company relied primarily on cash reserves and borrowing under the Revolverto fund operations. At June 30, 2006,the Company had available $17.3 millionof borrowing capacity under the Revolver.

Operatingactivities used $18.9 million of cash and $9.9 million of cash in the sixmonths ended June 30, 2006 and 2005,respectively, an increase of $9.0 million. The net loss increased $0.3 million from the prior-year period, and cashutilized by changes in operating assets and liabilities was $9.7 million morethan in the prior-year period.  Thecontinued utilization of cash to fund operating activities has necessitatedthat the Company borrow from its Revolver during the six months ended June 30,2006.  The Company anticipates that thistrend will continue through the remainder of 2006 and anticipates additionalborrowing on the Revolver will be required. Accounts receivable and inventory levels were higher at June 30, 2006due to timing issues on certain customer billings and higher in-process andfinished inventory related to items to be delivered later in 2006.

Investingactivities used net cash of $7.2 million and provided net cash of $.03 millionin the six months ended June 30, 2006and 2005, respectively.  The Company usedcash for purchases of property, plant and equipment of $8.9 million and $3.4million in the six months ended June 30, 2006 and 2005, respectively.  Thesewere offset by decreases in the amount of restricted cash of $1.8 million and$3.6 million for the same periods.

Financingactivities provided $15.7 million for the six months ended June 30, 2006compared with a use of $0.3 million for six months ended June 30, 2005.  Thefinancing activities for the six months ended June 30, 2006 increased theCompany’s debt while the use of cash in the prior year’s period relatedprimarily to the reduction of the Company’s debt.

At June 30, 2006, theCompany’s principal outstanding debt instruments consisted of (i) $16.7 millionoutstanding under the revolving credit facility maturing May 1, 2008 (which ismore fully described below), (ii)  $94.0million of 7.5% Senior Notes due 2008, and (iii) $103.8 million of SponsorNotes due 2009. The Company or its affiliates 

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may from time to timepurchase, redeem or pay deferred interest on some of its outstanding debt orequity securities.  The Company wouldonly make these payments in compliance with the covenants of its debtinstruments.

The Company continually reviews its various lines of business to assesstheir contribution to the Company’s business plan and from time to timeconsiders the sale of certain assets in order to raise cash or reducedebt.  Accordingly, the Company hasexplored and may explore possible asset sales by seeking expressions of interestfrom potential bidders.  However, theCompany has not entered into any binding agreements or agreements in principleto sell any assets and there can be no assurance that any such asset sales willoccur or, if they occur, as to the timing or amount of proceeds that such assetsales may generate.

 

**Revolving Credit Facility.**The Company has a revolving credit facility (the “Revolver”)provided by Heller Financial, Inc. (“Heller”). Effective March 31, 2006, the Company and Heller entered into anamendment to the Revolver which extended the maturity date from May 30, 2006 toMay 1, 2008.  The committed amount is $40 million,with a letter-of-credit sub-limit of $10 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.  Fundsavailability under the Revolver is determined by a borrowing-base formula equalto a specified percentage of the value of the Company’s eligible accountsreceivable (including accounts receivable of certain foreign subsidiaries),inventory, owned real property, machinery and equipment and pledged cash. Underthis borrowing-base formula, the total availability at June 30, 2006 was $34.0million.  At June 30, 2006, the Companyhad $16.7 million outstanding under the Revolver and no outstanding balance onletters-of-credit.  The availabilityremaining under the Revolver that the Company can draw was $17.3 million atJune 30, 2006.  A commitment fee of0.375% per annum on the unused portion of the Revolver is payable quarterly.

The interest rate onborrowings under the Revolver is, at the Company’s option, either (1) 0.25%over prime or (2) 1.75% over LIBOR.  AtJune 30, 2006, the Company’s weighted average rate on the Revolver was 7.3%.

The Revolver contains restrictionson the use of cash for dividend payments or non-scheduled principal payments oncertain indebtedness.  The Revolvercontains various representations, warranties and covenants, including financialcovenants as to minimum fixed charge coverage ratio and minimum averageborrowing availability.  Effective March31, 2006, the Company and Heller amended the loan and security agreement tostate that a covenant to maintain a specified fixed charge coverage ratio wouldapply only if the average daily availability for the three month period endingon the last day of the most recent calendar quarter is less than $15.0million.  At June 30, 2006, the Companywas in compliance with all covenants under the Revolver.

**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.  At June 30, 2006, the Company was incompliance with all covenants under the Senior Notes.

**Subordinated Unsecured SponsorNote**. The Company’s Sponsor Note bears interest at 10.0%, dueand payable quarterly. The Sponsor Note is subordinate only upon bankruptcy orinsolvency of the Company, or if upon maturity of the Senior Notes, the SeniorNotes remain unpaid.  The Sponsor Notematures on July 22, 2009.  WCAS may, atits election, defer each future quarterly payment under similar terms.  WCAS has not elected to defer the quarterlypayments since September 2001 and currently does not intend to elect deferralof the quarterly payments in the near future.

**Financing Arrangements.** During 2005, the Company entered into afinancing arrangement for $2.1 million that pertained to computersoftware.  At June 30, 2006, the Companyhad financing arrangement balances outstanding of $1.2 million, of which $0.6million was classified as current and $0.6 million was classified aslong-term.  This arrangement accruesinterest at a fixed 8.0% rate.  Thisarrangement is due in three annual installments of $0.7 million, which began January2006.

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

**Off Balance Sheet Arrangements. **The Company currently doesnot have any off balance sheet arrangements.

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### ** **

### **ContractualObligations and Commercial Commitments.**

In the normal course ofbusiness, the Company enters into various contractual and other commercialcommitments that impact, or could impact, the liquidity of operations. Thefollowing table outlines the commitments at June 30, 2006:
| ** **                             | ** ** | **Total Amounts** | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **Over 5 Years** | ** ** |
|----------------------------------------|------------|------------------------|------------|---------------------------------|------------|----------------|------------|----------------|------------|----------------------------|------------|
| ** **                             | ** ** | **(In Millions)** | ** ** |
| Long-term debt                         |       | $                      | 199.1      |                            | $          | 0.6            |       | $              | 94.7       |                       | $          | 103.8 |   | $ | — |   |
| Interest obligations on long-term debt |       | 50.1                   |       | 17.5                            |       | 29.1           |       | 3.5            |       | —                     |       |
| Capital leases                         |       | 2.4                    |       | 0.8                             |       | 1.1            |       | 0.5            |       | —                     |       |
| Operating leases (non-cancelable)      |       | 18.3                   |       | 5.8                             |       | 6.1            |       | 2.2            |       | 4.2                        |       |
| Total Contractual                      |       | $                      | 269.9      |                            | $          | 24.7           |       | $              | 131.0      |                       | $          | 110.0 |   | $ | 4.2 |   |
|                                   |       |                   |       |                            |       |           |       |           |       |                       |       |
| Unused lines of credit                 |       | $                      | 17.3       |                            | $          | 17.3           |       | $              | —     |                       | $          | — |   | $ | — |   |
| Standby letters of credit              |       | —                 |       | —                          |       | —         |       | —         |       | —                     |       |
| Total  Commercial                      |       | $                      | 17.3       |                            | $          | 17.3           |       | $              | —     |                       | $          | — |   | $ | — |   |

 

**RECENTACCOUNTING PRONOUNCEMENTS**

In June 2006, the Financial Accounting Standards Board (FASB) issuedFASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in IncomeTaxes-an Interpretation of FASB Statement No. 109”. FIN 48 prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.FIN 48 also provides guidance on de-recognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition. FIN 48 iseffective for fiscal years beginning after December 15, 2006. The Companyanticipates that FIN 48 will not have a material impact on the financialstatements.

 

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

 

TheCompany is subject to certain market risks arising from transactions in thenormal course of its business, and from obligations under its debt instruments.Such risk is principally associated with interest rate and foreign exchangefluctuations, as explained below.

**InterestRate Risk**

TheCompany utilizes long-term fixed rate and short-term variable rate borrowingsto finance the working capital and capital requirements of the business. AtJune 30, 2006, the Company had outstanding Senior Notes, due in 2008, of $94.0million, with a fixed interest rate of 7.5%. At June 30, 2006, the Company also had the Sponsor Note, due 2009, witha balance of $103.8 million. The Sponsor Note bears interest at a fixed rate of10.0%.

The interest rate onborrowings under the Revolver is, at the Company’s option, either (1) 0.25%over prime or (2) 1.75% over LIBOR.  AtJune 30, 2006, the Company’s weighted average rate on the Revolver was 7.3%. Abalance of $16.7 million was outstandingunder the Revolver at June 30, 2006. Based on $16.7 million in borrowings under the Revolver, a one hundredbasis point change in the bank’s prime or LIBOR rate would impact net interestexpense by $167,000 over a twelve-month period

**ForeignCurrency Risk**

TheCompany’s international subsidiaries operate in approximately 11 countries anduse the local currencies as the functional currency and the U.S. dollar as thereporting currency. Transactions between the Company and the internationalsubsidiaries are denominated in U.S. dollars. As a result, the Company hascertain exposures to foreign currency risk. However, management believes thatsuch exposure does not present a significant risk due to a relatively limitednumber of transactions and operations denominated in foreign currency.

Forthe six months ended June 30, 2006, approximately $75.3 million or 40.8% of theCompany’s revenues are denominated in the international currencies. Transactiongains and losses on U.S. dollar denominated transactions are recorded withinSundry, net in the accompanying consolidated statements of operations and werenot material.

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TheCompany may use foreign forward currency-exchange rate contracts to minimizethe adverse earnings impact from the effect of exchange rate fluctuations. Nohedging instruments existed at June 30, 2006.

**ITEM 4. CONTROLS AND PROCEDURES.**

As of the end of theperiod covered by this report, June 30, 2006, the Chief Executive Officer andthe Chief Financial Officer of the Company, with the participation of theCompany’s management, evaluated the effectiveness of the Company’s disclosurecontrols and procedures pursuant to Exchange Act Rule 13a-15.  Based upon this evaluation, the ChiefExecutive Officer and the Chief Financial Officer believe that 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.  In addition, the disclosure controls and proceduresare effective to ensure that information required to be disclosed in thisreport is recorded, processed, summarized and reported within 90 days of June30, 2006, and such information required to be disclosed is accumulated andcommunicated to management as appropriate to allow timely decisions regardingrequired disclosure.  The Company willcontinue to evaluate disclosure controls on an ongoing basis.

Disclosure controls andprocedures, no matter how well designed and implemented, can provide onlyreasonable assurance of achieving an entity’s disclosure objectives.  The likelihood of achieving such objectivesis affected by limitations inherent in disclosure controls and procedures.  These include the fact that human judgment indecision-making can be faulty and that breakdowns in internal control can occurbecause of human failures such as simple errors or mistakes or intentionalcircumvention of the established process. The Company’s disclosure controls and procedures are designed to providereasonable assurance of achieving their objectives, and the Chief ExecutiveOfficer and Chief Financial Officer believe that the Company’s disclosurecontrols and procedures are effective at that reasonable assurance level.

There were nosignificant changes in the Company’s internal controls over financial reportingor in other factors that could significantly affect internal controls, known tothe Chief Executive Officer or the Chief Financial Officer, during the secondquarter of 2006.

 

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**BANCTEC, INC.PART IIOTHER INFORMATION**

**ITEM 1. Legal Proceedings**

TheCompany is a party to various legal proceedings.  None of those current proceedings is expectedto have an outcome that is material to the financial condition or operations ofthe Company.

**ITEM 1A. Risk Factors**

Information provided bythe Company in this Quarterly Report on Form 10-Q and other documents filedwith the Securities and Exchange Commission include “forward-looking”information, as that term is defined in the Private Securities LitigationReform Act of 1995 (the “PSLRA”). Allstatements other than statements of historical fact could be deemedforward-looking statements.  TheCompany cautions investors that actual results or business conditions maydiffer materially from those projected or suggested in such forward-lookingstatements as a result of numerous factors beyond the Company’s control. TheCompany undertakes no obligation to update or revise forward-looking statementsto reflect changes in assumptions, the occurrence of unanticipated results orchanges to future operating results over time. The following is a descriptionof some of the important factors that may cause the actual results of theCompany’s operations in future periods to differ materially from those currentlyexpected or desired.

***Businessand Economic Conditions***

The Company’s businesspartially depends on business conditions in certain industries. The Company’ssales are concentrated to businesses in industries involving high volumetransaction processing, including banking, financial services, insurance,health care and high technology, and to governmental agencies.  Business or economic conditions, such asconsolidation with the industry, that cause customers in these industries toreduce or delay their investments in document processing products andsolutions, such as those offered by the Company, could have a material adverseeffect on the Company, including its business, operating results, financialcondition and prospects.

Delays or reductions intechnology spending could have a material adverse effect on demand for theCompany’s products and services, and consequently on the Company.

***TechnologicalChanges and Product Transitions***

The Company’s industry ischaracterized by continuing improvement in technology, which results in thefrequent introduction of new products, short product life cycles and continualimprovement in product price/performance characteristics.  The Company must incorporate these newtechnologies into its products and solutions in order to remain competitive.The Company may not be able to continue to manage technologicaltransitions.  A failure on the part ofthe Company to effectively manage these transitions of its product lines to newtechnologies on a timely basis could have a material adverse effect,specifically reductions in sales, on the Company.  In addition, the Company’s business dependson technology trends in its customers’ businesses.  Many of the Company’s traditional productsdepend on the efficient handling of paper-based transactions.  To the extent that technological changesimpact the future volume of paper transactions, the Company’s traditionalbusiness may be adversely impacted.

***Dependenceon Suppliers***

The Company’s hardwareproducts depend on the quality of components that are procured from third-partysuppliers.  Reliance on suppliers, aswell as industry supply conditions, generally involves several risks, includingthe possibility of defective parts (which can adversely affect the reliabilityand reputation of the Company’s products), a shortage of components and reducedcontrol over delivery schedules (which can adversely affect the Company’smanufacturing efficiencies) and increases in component costs (which canadversely affect the Company’s profitability).

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The Company has severalsingle-sourced supplier relationships, either because alternative sources arenot available or the relationship is advantageous due to performance, quality,support, delivery, capacity or price considerations.  If these sources are unable to provide timelyand reliable supply, the Company could experience manufacturing interruptions,delays or inefficiencies, adversely affecting its results of operations. Evenwhere alternative sources of supply are available, qualification of the alternativesuppliers and establishment of reliable supplies could result in delays and apossible loss of sales, which could affect operating results adversely.

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

As a result of the Company’s high debt to equity ratio,the Company is required to devote significant cash to debt service.   This limits the Company’s future operatingflexibility and could make the Company more vulnerable to a downturn in itsoperating performance or a decline in general economic conditions.

***InternationalActivities***

The Company’sinternational operations are a significant part of the Company’s business.  The success and profitability ofinternational operations are subject to numerous risks and uncertainties, suchas economic and labor conditions, political instability, tax laws (includingU.S. taxes on foreign subsidiaries) and changes in the value of the U.S. dollarversus 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.

***Fluctuationsin Operating Results***

The Company’s operatingresults may fluctuate from period to period and will depend on numerousfactors, including the following: customer demand and market acceptance of theCompany’s products and solutions, new product introductions, productobsolescence, varying product mix, foreign-currency exchange rates, competitionand other factors. The Company’s business is sensitive to the spending patternsof its customers, which in turn are subject to prevailing economic conditionsand other factors beyond the Company’s control. In addition, recent lawsgoverning check truncation could reduce the demand for the Company’s paymentproducts.  Any unfavorable change in oneor more of these factors could have a material adverse effect on the Company.

***ProductDevelopment Activities***

The strength of theCompany’s overall business depends in part on the Company’s ability to developproducts and solutions based on new or evolving technology and the market’sacceptance of those products.  There canbe no assurance that the Company’s product development activities will besuccessful, that new technologies will be available to the Company, that theCompany will be able to deliver commercial quantities of new products in atimely manner, that those products will adhere to generally accepted industrystandards or that products will achieve market acceptance.  Many of the Company’s customers use itsproducts in highly regulated or technologically demanding industries.  As a result of products introduced by theCompany’s competitors, generally accepted industry standards can change rapidlyin ways that are beyond the control of the Company.

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

None

**ITEM 3.  Defaults Upon Senior Securities**

None

**ITEM4.  Submission of Matters to a Vote ofSecurity Holders**

None

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**ITEM 5. Other Information**

None

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

(a)          Exhibits:

31.1 — Certification of Chief Executive Officer pursuant to Rule15d-14(a) under the Securities Exchange Act

31.2 — Certification of Chief Financial Officer pursuant to Rule15d-14(a) under the Securities Exchange Act

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

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

(b)         Reports on Form 8-K:

No reports on Form 8-Kwere filed during the three months ended June 30, 2006.

 

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

**BancTec, Inc.**
|          | *By*     |                                 |
|----------|----------|--------------------------------------|
| * * | * * | *Jeffrey D. Cushman*                 |
| * * | * * | *Senior Vice President on behalf of* |
| * * | * * | *the registrant and as Chief*        |
| * * | * * | *Financial Officer*                  |

 

Dated: August 14, 2006

 

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