**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý****        QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities**

**ExchangeAct of 1934**

 

**For the quarterly period ended June 30,2005**

 

**OR**

 

**o****        TransitionReport Pursuant to Section 13 or 15(d) of the Securities**

**ExchangeAct of 1934**

 

**Commission File Number 0-9859**

 

**BANCTEC,INC.**

(Exact name of registrant as specified in itscharter)

 
| **DELAWARE**                                                    | ** ** | **75-1559633**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |
|                                                            |       |                                 |
| **2701 E. Grauwyler Road, Irving, Texas**                       | ** ** | **75061**                            |
| (Address of principal executive offices)                        |       | (Zip Code)                           |

 

**(972) 821-4000**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.                                         Yes  ý     No  o

 

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

 

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

 
| ** **                                 | ** ** | **Number  of Shares Outstanding at** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|
| **Title of Each Class**                    | ** ** | **August 10,  2005**            | ** ** |
|                                       |       |                                 |       |
| Common Stock, $0.01 par value              |       | 17,003,838                           |       |
| Class A Common Stock, $0.01 par value |       | 1,181,946                            |       |

 

 

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**PART I**

 

**FINANCIAL INFORMATION**

 

**ITEM 1.  Financial Statements**

** **

**BANCTEC, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

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

 
| ** **                                                                                                                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                         | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                                                                                                                         | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| CURRENT ASSETS:                                                                                                                    |       |              |       |                  |       |
| Cash and cash equivalents,  including restricted cash of $428 and $4,056 at June 30, 2005 and  December 31, 2004         |       | $                 | 36,942     |                  | $          | 51,487 |   |
| Accounts receivable, less  allowance for doubtful accounts of  $879 and $931 at June 30, 2005 and December 31, 2004 |       | 45,544            |       | 45,772                |       |
| Inventories, net                                                                                                                   |       | 21,534            |       | 24,466                |       |
| Prepaid expenses                                                                                                                   |       | 6,103             |       | 4,950                 |       |
| Other current assets                                                                                                               |       | 2,021             |       | 1,984                 |       |
| Total current assets                                                                                                               |       | 112,144           |       | 128,659               |       |
|                                                                                                                               |       |              |       |                  |       |
| PROPERTY, PLANT AND EQUIPMENT,  net                                                                                                |       | 30,792            |       | 34,254                |       |
|                                                                                                                               |       |              |       |                  |       |
| OTHER ASSETS:                                                                                                                      |       |              |       |                  |       |
| Goodwill                                                                                                                           |       | 41,476            |       | 41,476                |       |
| Deferred income tax benefit                                                                                                        |       | 6,735             |       | 6,874                 |       |
| Other assets                                                                                                                       |       | 4,357             |       | 4,802                 |       |
| Total other assets                                                                                                                 |       | 52,568            |       | 53,152                |       |
|                                                                                                                               |       |              |       |                  |       |
| TOTAL ASSETS                                                                                                                       |       | $                 | 195,504    |                  | $          | 216,065 |   |
|                                                                                                                               |       |              |       |                  |       |
| CURRENT LIABILITIES:                                                                                                               |       |              |       |                  |       |
| Current obligations under  capital leases and revolver                                                                             |       | $                 | 103        |                  | $          | 299 |   |
| Trade accounts payable                                                                                                             |       | 13,478            |       | 14,479                |       |
| Other accrued expenses and  liabilities                                                                                            |       | 36,384            |       | 34,377                |       |
| Deferred revenue                                                                                                                   |       | 18,746            |       | 23,778                |       |
| Maintenance contract deposits                                                                                                      |       | 33,787            |       | 41,083                |       |
| Income taxes                                                                                                                       |       | 4,385             |       | 3,112                 |       |
| Total current liabilities                                                                                                          |       | 106,883           |       | 117,128               |       |
|                                                                                                                               |       |              |       |                  |       |
| OTHER LIABILITIES:                                                                                                                 |       |              |       |                  |       |
| Long-term debt                                                                                                                     |       | 197,823           |       | 197,823               |       |
| Non-current maintenance  contract deposits                                                                                         |       | 18,013            |       | 20,547                |       |
| Other non-current liabilities                                                                                                      |       | 22,150            |       | 22,230                |       |
| Total other liabilities                                                                                                            |       | 237,986           |       | 240,600               |       |
|                                                                                                                               |       |              |       |                  |       |
| Total liabilities                                                                                                                  |       | 344,869           |       | 357,728               |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                      |       |              |       |                  |       |
|                                                                                                                               |       |              |       |                  |       |
| SERIES A PREFERRED STOCK -  issued and outstanding, 100,667 shares at June 30, 2005 and  December 31, 2004               |       | 18,040            |       | 18,040                |       |
|                                                                                                                               |       |              |       |                  |       |
| STOCKHOLDERS’ DEFICIT:                                                                                                        |       |              |       |                  |       |
| Cumulative preferred stock -  authorized, 200,000 shares of $0.01 par value at June 30, 2005 and  December 31, 2004      |       |              |       |                  |       |
| Series B preferred stock -  issued and outstanding,  35,520  shares at June 30, 2005 and December 31, 2004     |       | 13,520            |       | 13,520                |       |
| Common stock authorized,  21,800,000 shares of $0.01 par value at  June 30, 2005 and December 31, 2004:             |       |              |       |                  |       |
| Common stock-issued and  outstanding  17,003,838  shares at June 30, 2005 and December 31, 2004                     |       | 170               |       | 170                   |       |
| Class A common  stock-issued and outstanding 1,181,946 shares  At June 30, 2005 and December 31,  2004         |       | 12                |       | 12                    |       |
| Subscription stock warrants                                                                                                        |       | 3,726             |       | 3,726                 |       |
| Additional paid-in capital                                                                                                         |       | 122,655           |       | 122,655               |       |
| Accumulated deficit                                                                                                                |       | (292,679          | )          | (286,247              | )          |
| Accumulated other comprehensive  loss                                                                                              |       | (14,809           | )          | (13,539               | )          |
| Total stockholders’ deficit                                                                                                   |       | (167,405          | )          | (159,703              | )          |
|                                                                                                                               |       |              |       |                  |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                  |       | $                 | 195,504    |                  | $          | 216,065 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

2

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**BANCTEC, INC.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                 | ** ** |
| REVENUE                              |       |                                  |       |                               |       |   |   |   |   |
| Equipment and software               |       | $                                     | 31,399     |                               | $          | 42,060 |   | $ | 65,810 |   | $ | 74,586 |   |
| Maintenance and other services       |       | 53,035                                |       | 57,759                             |       | 107,259 |   | 114,317 |   |
|                                 |       | 84,434                                |       | 99,819                             |       | 173,069 |   | 188,903 |   |
| COST OF SALES                        |       |                                  |       |                               |       |   |   |   |   |
| Equipment and software               |       | 18,591                                |       | 28,198                             |       | 38,816 |   | 47,433 |   |
| Maintenance and other services       |       | 44,881                                |       | 45,496                             |       | 89,080 |   | 94,242 |   |
|                                 |       | 63,472                                |       | 73,694                             |       | 127,896 |   | 141,675 |   |
|                                 |       |                                  |       |                               |       |   |   |   |   |
| Gross profit                         |       | 20,962                                |       | 26,125                             |       | 45,173 |   | 47,228 |   |
|                                 |       |                                  |       |                               |       |   |   |   |   |
| OPERATING EXPENSES                   |       |                                  |       |                               |       |   |   |   |   |
| Product development                  |       | 2,580                                 |       | 2,078                              |       | 4,831 |   | 4,563 |   |
| Selling, general and  administrative |       | 17,247                                |       | 16,310                             |       | 34,291 |   | 30,961 |   |
|                                 |       | 19,827                                |       | 18,388                             |       | 39,122 |   | 35,524 |   |
|                                 |       |                                  |       |                               |       |   |   |   |   |
| Income from operations               |       | 1,135                                 |       | 7,737                              |       | 6,051 |   | 11,704 |   |
|                                 |       |                                  |       |                               |       |   |   |   |   |
| OTHER INCOME (EXPENSE):              |       |                                  |       |                               |       |   |   |   |   |
| Interest income                      |       | 201                                   |       | 153                                |       | 428 |   | 291 |   |
| Interest expense                     |       | (4,753                                | )          | (4,781                             | )          | (9,512 | ) | (9,554 | ) |
| Sundry, net                          |       | (241                                  | )          | (1,498                             | )          | (717 | ) | (1,992 | ) |
|                                 |       | (4,793                                | )          | (6,126                             | )          | (9,801 | ) | (11,255 | ) |
|                                 |       |                                  |       |                               |       |   |   |   |   |
| (LOSS) INCOME BEFORE INCOME  TAXES   |       | (3,658                                | )          | 1,611                              |       | (3,750 | ) | 449 |   |
| INCOME TAX EXPENSE                   |       | 1,330                                 |       | 3,290                              |       | 2,682 |   | 2,920 |   |
|                                 |       |                                  |       |                               |       |   |   |   |   |
| NET LOSS                             |       | (4,988                                | )          | (1,679                             | )          | (6,432 | ) | (2,471 | ) |
|                                      |            |                                       |            |                                    |            |  |  |  |  |  |  |  |  |

 

See notes to unaudited condensedconsolidated financial statements.

 

3

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**BANCTEC, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                                                      | ** ** | **(In thousands)**                 | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES                                           |       |                               |       |   |   |
| Net loss                                                                        |       | $                                  | (6,432     | ) | $ | (2,471 | ) |
| Adjustments to reconcile to  cash flows provided by operations:                 |       |                               |       |   |   |
| Depreciation and amortization                                                   |       | 7,367                              |       | 7,844 |   |
| Provision for doubtful accounts                                                 |       | (111                               | )          | (132 | ) |
| Deferred income tax expense                                                     |       | 139                                |       | 990 |   |
| Loss on disposition of  property, plant and equipment                           |       | 522                                |       | 338 |   |
| Other non-cash items                                                            |       | 34                                 |       | 292 |   |
| Changes in operating assets and  liabilities                                    |       |                               |       |   |   |
| Decrease (increase) in accounts  receivable                                     |       | 339                                |       | (6,873 | ) |
| Decrease in inventories                                                         |       | 1,392                              |       | 3,912 |   |
| Increase in other assets                                                        |       | (675                               | )          | (270 | ) |
| (Decrease) increase in trade  accounts payable                                  |       | (1,001                             | )          | 850 |   |
| Decrease in deferred  revenue & maintenance contracts deposits         |       | (14,862                            | )          | (5,058 | ) |
| Increase in other accrued  expenses and liabilities                             |       | 3,267                              |       | 5,434 |   |
| Cash flows (used in) provided  by operating activities                          |       | (10,021                            | )          | 4,856 |   |
|                                                                            |       |                               |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                            |       |                               |       |   |   |
| Purchases of property, plant  and equipment                                     |       | (3,351                             | )          | (3,453 | ) |
| Proceeds from sale of property,  plant and equipment                            |       | —                             |       | 297 |   |
| Cash flows used in investing  activities                                        |       | (3,351                             | )          | (3,156 | ) |
|                                                                            |       |                               |       |   |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES                                           |       |                               |       |   |   |
| Payments of current maturities  of long-term debt and capital lease obligations |       | (241                               | )          | (565 | ) |
| Payments on short-term  borrowings, net                                         |       | (1                                 | )          | — |   |
| Debt issuance costs                                                             |       | (70                                | )          | (50 | ) |
| Cash flows used in financing  activities                                        |       | (312                               | )          | (615 | ) |
|                                                                            |       |                               |       |   |   |
| EFFECT OF EXCHANGE RATE CHANGES  ON CASH                                        |       | (861                               | )          | 328 |   |
| NET (DECREASE) INCREASE IN CASH  AND CASH EQUIVALENTS                           |       | (14,545                            | )          | 1,413 |   |
| CASH AND CASH  EQUIVALENTS-BEGINNING OF YEAR                                    |       | 51,487                             |       | 61,566 |   |
|                                                                            |       |                               |       |   |   |
| CASH AND CASH EQUIVALENTS-END  OF PERIOD                                        |       | $                                  | 36,942     |   | $ | 62,979 |   |
|                                                                            |       |                               |       |   |   |
| SUPPLEMENTAL DISCLOSURES  INFORMATION:                                          |       |                               |       |   |   |
| Cash paid during the period  for:                                               |       |                               |       |   |   |
| Interest                                                                        |       | $                                  | 8,848      |   | $ | 8,877 |   |
| Taxes                                                                           |       | $                                  | 973        |   | $ | 1,285 |   |

 

See notes to unaudited condensedconsolidated financial statements.

 

4

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**BANCTEC, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

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

 

The accompanying unaudited condensedconsolidated balance sheet at June 30, 2005, and the unaudited condensed consolidated statements ofoperations and cash flows for the interim periods ended June 30, 2005 and2004, should be read in conjunction with BancTec, Inc. and subsidiaries (“BancTec”or the “Company”) consolidated financial statements and notes thereto in themost recent Annual Report on Form 10-K filed with the Securities andExchange Commission.  In the opinion ofmanagement, the accompanying condensedconsolidated financial statements contain all material adjustments, consistingprincipally of normal recurring adjustments, necessary for a fair presentationof the financial position and results of operations of the Company. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

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

 

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

 

**Use of Estimates**

 

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

 

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

 

Cash and cash equivalents include cash onhand and on deposit, including highly liquid investments with originalmaturities of three months or less. Short-term investments or similarinstruments with original maturities in excess of three months are valued atcost, which approximates market. Restricted cash at June 30,2005, of $0.4 million represents the cash pledged under the terms of theRevolving Credit Facility (See Note 8).

 

**Allowance for Doubtful Accounts**

 

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

 

**Inventories**

 

Inventories are valued at the lower of costor market and include the cost of raw materials, labor, factory overhead, andpurchased subassemblies. Cost is determined using the first-in, first-out andweighted average methods.  At leastquarterly, the Company evaluates the carrying amount of inventorybased on the identification of excess and obsolete inventory. The Company’sevaluation involves a multi-element approach incorporating the stratificationof inventory by time held and the stratification of inventory by risk category,among other elements.  The approachincorporates both recent historical information and management estimates oftrends. The Company’s approach is intended to take into consideration potentialexcess and obsolescence caused by a decreasing installed base, engineeringchanges and end of manufacture.  If anyof the elements of the Company’s estimate were to deteriorate, additionalwrite-downs may be required. The inventory write-down calculations are reviewedperiodically and additional write-downs are recorded as deemed necessary.  Inventoryreserves as of June 30, 2005 and December 31, 2004, were $12.4million and $13.6 million, respectively. Inventory reserves establish a new cost basis for inventory and are notreversed in future periods.

 

5

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**Property, Plant, and Equipment**

 

Property, plant, and equipment are recordedat cost and are depreciated or amortized principally on a straight-line basisover the estimated useful lives of the related assets. Estimated useful livesrange from two to five years for field support spare parts, three to eightyears for systems and software, five to seven years for machinery andequipment, leasehold improvements, and furniture and fixtures. Buildings aredepreciated over 40 years.  Depreciationexpense for the three months ended June 30, 2005 and 2004 was $3.8 millionand $4.0 million respectively. Depreciation expense for the six months ended June 30, 2005 and2004 was $7.4 million and $7.8 million respectively.

 

**Revenue Recognition**

 

The Company derives revenue primarily from two sources: (1) productsales - systems integration solutions which address complex data andpaper-intensive work processes, including advanced web-enabled imaging andworkflow technologies with both BancTec-manufactured equipment and third-party equipment, and (2) 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 applies the provisions of Statement of Position 97-2, “SoftwareRevenue Recognition,” as amended by Statement of Position 98-9 “Modificationof SOP 97-2, Software Revenue Recognition, With Respect to CertainTransactions” to all transactions involving the sale of software products andsales of hardware where the software is not incidental. For those transactionsthat involve acceptance certificates, the Company recognizes revenue uponreceipt of the acceptance certificate, or when it can be objectivelydemonstrated that acceptance criteria have been met.  For hardware transactions where software isconsidered incidental, or no software is included, revenue is recognized whenthe product has been delivered and all initial obligations have been fulfilled.

 

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

 

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

 

Maintenance contracts are primarily one yearin duration and the revenue generated is generally recognized ratably over theterm of the contract.

 

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

 

**Research and Development**

 

Research and development costs are expensedas incurred.  Research and developmentcosts for the six months ended June 30, 2005, and 2004, were $4.8 millionand $4.6 million respectively.

 

**Income Taxes**

 

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

 

6

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

 

**Foreign Currency Translation**

 

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

 

**Stock-Based Compensation**

 

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

 

2000 Stock Plan:

 

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

 

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

 

Non-qualified stock options. During the yearended December 31, 2004, the Company granted 50,000 non-qualifiedoptions.  During the six months ended June 30,2005, no non-qualified options were granted. Under the Plan, non-qualified options are granted at a fixed exerciseprice equal to, more than, or less than 100% of the fair value of the shares ofstock on the date of grant. A portion of the non-qualified options vest over afour-year period at 25% per year beginning January 2, 2001; the remaindervest based on the performance of the Company. As a part of an employeeretention program, vesting of 20.0% of the performance-based incentive optionswas accelerated in October 2000.

 
| ** **                                  | ** ** | **Incentive   Shares** | ** ** | **Non-qualified   Shares** | ** ** | **Weighted   Average   Exercise   Price** | ** ** |
|---------------------------------------------|------------|------------------------|------------|----------------------------|------------|-------------------------------------------|------------|
| Options  outstanding-December 31, 2003 |       | 482,240                |       | 31,760                     |       | 9.25                                      |       |
| Granted                                     |       | 1,419,500              |       | 50,000                     |       | 9.25                                      |       |
| Forfeited                                   |       | (126,500               | )          | (50,000                    | )          | 9.25                                      |       |
| Options  outstanding-December 31, 2004 |       | 1,775,240              |       | 31,760                     |       | 9.25                                      |       |
| Granted                                     |       | 485,000                |       | —                     |       | 9.25                                      |       |
| Forfeited                                   |       | —                 |       | —                     |       | 9.25                                      |       |
| Options  outstanding-June 30, 2005     |       | 2,260,240              |       | 31,760                     |       | 9.25                                      |       |

 

Options and awards expire and terminate theearlier of ten years from the date of grant or one month after the date theemployee ceases to be employed by the Company.

 

At June 30, 2005, options to purchase2,292,000 shares were outstanding, of which 316,125 were vested.  All options outstanding have an exerciseprice of $9.25.  No options have beenexercised.

 

7

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Under the intrinsic-value method,compensation expense is recorded only to the extent that the strike price isless than the fair value price on the measurement date.  All options granted in 2004 and 2005 wereissued at or above fair value price, and therefore no stock-based compensationwas recorded.

 

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

 
| ** **                                                                                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                              | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                           | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                 | ** ** |
| Net loss as reported                                                                                                 |       | $                                     | (4,988     | )                                  | $          | (1,679 | ) | $ | (6,432 | ) | $ | (2,471 | ) |
| Total stock-based employee compensation  expense determined under fair-value based method for all awards, net of tax |       | (423                                  | )          | (19                                | )          | (744 | ) | (39 | ) |
| Pro Forma net loss                                                                                                   |       | $                                     | (5,411     | )                                  | $          | (1,698 | ) | $ | (7,176 | ) | $ | (2,510 | ) |

 

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

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

 

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

 

## *Reclassification*

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

 

## *Impairment*

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

 

## *Change in Accounting Estimate*

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

 

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

 

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

 
| ** **                                                        | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                        | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | **(In thousands)**                 | ** ** |
| Capital lease obligation incurred for lease  of computer hardware |       | $                                  | —     |   | $ | 241 |   |
| Inventory put in service as fixed asset                           |       | 1,537                              |       | 105 |   |
|                                                                   |            |                                    |            |  |  |  |  |

 

8

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**5.****                                      INVENTORIES**

 

Inventory consists of the following:

 
| ** **       | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
|------------------|------------|--------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **       | ** ** | **(In thousands)** | ** ** |
| Raw materials    |       | $                  | 5,936      |                  | $          | 6,686 |   |
| Work-in-progress |       | 4,484              |       | 5,247                 |       |
| Finished goods   |       | 11,114             |       | 12,533                |       |
|             |       | $                  | 21,534     |                  | $          | 24,466 |   |

 

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

 

Property, plant and equipment consist of thefollowing:

 
| ** **                                 | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| Land                                       |       | $                  | 2,860      |                  | $          | 2,860 |   |
| Field support spare parts                  |       | 36,616             |       | 38,057                |       |
| Systems and software                       |       | 52,451             |       | 51,802                |       |
| Machinery and equipment                    |       | 20,964             |       | 21,517                |       |
| Furniture, fixtures and other              |       | 11,110             |       | 11,924                |       |
| Buildings                                  |       | 27,533             |       | 26,529                |       |
|                                       |       | 151,534            |       | 152,689               |       |
| Accumulated depreciation and  amortization |       | 120,742            |       | 118,435               |       |
| Property, plant and equipment,  net        |       | $                  | 30,792     |                  | $          | 34,254 |   |

 

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

 

Other accrued expenses and liabilitiesconsist of the following:

 
| ** **                              | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Salaries, wages and other  compensation |       | $                  | 15,630     |                  | $          | 10,081 |   |
| Accrued taxes, other than  income taxes |       | 3,464              |       | 4,868                 |       |
| Accrued interest payable                |       | 3,201              |       | 3,204                 |       |
| Accrued invoices and costs              |       | 1,940              |       | 1,191                 |       |
| Other                                   |       | 12,149             |       | 15,033                |       |
|                                    |       | $                  | 36,384     |                  | $          | 34,377 |   |

 

9

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

 

Debt and other obligations consist of thefollowing:

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

 

Revolving Credit Facility.  TheCompany has a revolving credit facility (the “Revolver”) provided by HellerFinancial, Inc. (“Heller”), which will mature on May 30, 2006.  Effective May 7, 2003, theCompany and Heller entered into an amendment to the Revolver which reduced thecommitted amount from $60 million to $40 million, while increasing theletter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.  Fundsavailability under the Revolver is determined by a borrowing-base formula equalto a specified percentage of the value of the Company’s eligible accountsreceivable, inventory and pledged cash. At June 30, 2005, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $0.3million.  The balance remaining under theRevolver that the Company can draw was $ 15.5 million at June 30, 2005 ($19.5 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 1.25% over prime or (2) 2.75% over LIBOR.  Under an amendment effective September 1,2003, the interest rate margins over prime and LIBOR may be increased by 0.25%increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0and (2) 1.25 to 1.0 (total rate increase of 0.50%) or decreased by 0.25%increments when the fixed charge coverage ratio is greater than (1) 1.75to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of0.75%).  The interest rate was remeasuredas of the effective date of September 1, 2003 under this amendment.  At June 30, 2005, the Company’s weightedaverage rate on the Revolver was 8.0% under the prime option.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at June 30, 2005 of $0.4 million represents cashpledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties andcovenants, including financial covenants as to maximum capital expenditures,minimum fixed charge coverage ratio and minimum average borrowingavailability.  Effective December 31,2004, the Company and Heller amended the loan and security agreement todecrease the minimum fixed charge coverage ratio at December 31, 2004 to1.1 to 1.0.  Effective March 31,2005, the loan and security agreement was further amended to add a triggeringevent for the fixed charge coverage ratio covenant.  No fixed charge coverage ratio covenantapplies when cash balances exceed $20 million and the outstanding balance onthe revolver is less than $250,000.  Ifeither of these conditions is not met, then the fixed charge covenant ratiorequirement becomes 1.1 to 1.0.  At June 30,2005, the Company was in compliance with all covenants under the Revolver.

 

Senior Notes. Interest on the Senior Notes is fixed at 7.5% and is due and payable insemi-annual installments. Payments began December 1, 1998. The Notescontain covenants placing limitations on the Company’s ability to permitsubsidiaries to incur certain debts, incur certain loans, and engage in certainsale and leaseback transactions.  The estimated fair value of the SeniorNotes as of June 30, 2005, is approximately $66.9 million based on anaverage value of the most recently completed market trades, resulting in ayield-to-maturity of approximately 21%. The number of actual trades is limited; therefore, the result may varyif a widely traded market environment existed.

 

10

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Subordinated Unsecured Sponsor Note. TheCompany’s Sponsor Note bears interest at 10.0%, due and payable quarterly. TheSponsor Note is subordinate only upon bankruptcy or insolvency of the Company,or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999.As provided under the agreement, however, the Sponsor Note holder, Welsh,Carson, Anderson & Stowe (“WCAS’), elected to defer quarterly interestpayments of $4.0 million for each of the September 2000 through September 2001quarterly periods resulting in an increase in the principal amount of theSponsor Note totaling $33.8 million. Such election required a deferred financing-fee of 30.0% of each of theinterest payments being deferred.  TheCompany accounts for the additional financing fees as a change in the effectiveinterest rate of the debt. WCAS may, at its election, defer each futurequarterly payment under similar terms. WCAS has not elected to defer the quarterly payments since September 2001.  In accordance with the terms of the SponsorNote, on December 6, 2002, the Company made a $90.0 million principalpayment on the Sponsor Note.  Theestimated fair-value of the Sponsor Note and deferred interest and fees as of June 30,2005, is approximately $63.3 million assuming a yield-to-maturity of 26%.

 

The Company had no outstanding balances onforeign credit agreements at June 30, 2005.

 

Capital Leases.  Amounts due under capital leases are recordedas liabilities. The Company’s interest in assets acquired under capital leasesis recorded as property and equipment on the Condensed Consolidated BalanceSheets. Amortization of assets recorded under capital leases is included indepreciation expense.  The currentobligations under capital leases are classified in the current liabilities section ofthe Condensed Consolidated Balance Sheets and the non-current portion ofcapital leases are included in Other Liabilities.  At June 30, 2005, the Company hadcapital lease balances outstanding of $0.2 million, of which $0.1 million wasclassified as current and $0.1 million was classified as long-term.

 

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

 

Beginning January 1, 2002, the Companyadopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwilland Other Intangible Assets”.  SFAS No. 142requires that goodwill and intangible assets with indefinite useful lives nolonger be amortized but instead be tested for impairment at leastannually.  SFAS No. 142 alsorequires that intangible assets with definite useful lives be amortized overtheir respective estimated useful lives to their estimated residual values.

 

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

 

Components of the Company’s goodwill include amounts that are foreigncurrency denominated.  These goodwillamounts are subject to translation at each balance sheet date.  The Company records the change to itsAccumulated Other Comprehensive Loss on the balance sheet.  Goodwill previously classified as unallocatedhas been allocated to the reporting units as required by SFAS No. 142.  There were no changes in the carrying amount of goodwill by segment for the six monthsended June 30, 2005 or June 30, 2004.

 

**10.****                               PENSIONBENEFITS**

 

Net periodic pension costs included the following components for thethree and six months ended June 30:

 
| ** **                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **2005**                              | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                    | ** ** | **(In thousands)**                 | ** ** |
| Components of net periodic  benefits cost: |       |                                  |       |                               |       |   |   |   |   |
| Service cost                               |       | $                                     | 103        |                               | $          | 112 |   | $ | 201 |   | $ | 224 |   |
| Interest cost                              |       | 366                                   |       | 397                                |       | 715 |   | 794 |   |
| Expected return on plan assets             |       | (253                                  | )          | (274                               | )          | (494 | ) | (548 | ) |
| Recognized actuarial loss                  |       | 100                                   |       | 108                                |       | 195 |   | 216 |   |
| Net periodic benefit cost                  |       | $                                     | 316        |                               | $          | 343 |   | $ | 617 |   | $ | 686 |   |

 

**Company Contributions**

 

TheCompany previously disclosed in its financial statements for the year ended December 31,2004, that it expected to contribute $1.3 million to the pension plan during2005.  As of June 30, 2005, $0.6million of contributions have been made. The Company presently anticipates continuing its contributions to thepension plan to total $1.6 million for 2005.

 

11

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**11.****                               TAXES**

 

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

 
| ** **                             | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                             | ** ** | **(In thousands)** | ** ** |
| Gross deferred tax assets:             |       |               |       |                  |       |
| Net operating losses                   |       | $                  | 51,478     |                  | $          | 47,335 |   |
| AMT credit carryforwards               |       | 101                |       | 101                   |       |
| Inventory reserves                     |       | 4,593              |       | 4,948                 |       |
| Receivable allowance                   |       | 200                |       | 205                   |       |
| Intangible assets previously  deducted |       | 687                |       | 905                   |       |
| Deferred revenues                      |       | 14,967             |       | 15,450                |       |
| Deferred compensation                  |       | 3,526              |       | 2,639                 |       |
| Foreign timing differences, net        |       | 9,088              |       | 9,088                 |       |
| Other                                  |       | 5,410              |       | 5,723                 |       |
| Total gross deferred tax asset         |       | 90,050             |       | 86,394                |       |
| Gross deferred tax liabilities:        |       |               |       |                  |       |
| Depreciation                           |       | (1,458             | )          | (1,352                | )          |
| Total gross deferred tax  liability    |       | (1,458             | )          | (1,352                | )          |
| Deferred tax asset valuation  reserve  |       | (79,873            | )          | (76,184               | )          |
| Net deferred tax asset                 |       | $                  | 8,719      |                  | $          | 8,858 |   |

 

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

 

Components of the valuation allowance are as follows:

 
| ** **                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|
| ** **                                | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(In thousands)**                 | ** ** |
| Valuation allowance at beginning of year  |       | $                                  | 76,184     |   | $ | 63,874 |   |
| (Release) Increase in valuation allowance |       | (167                               | )          | (258 | ) |
| Income from continuing operations         |       | 3,856                              |       | 69 |   |
| Prior year true-ups and corrections       |       | —                             |       | — |   |
| Valuation allowance at end of period      |       | $                                  | 79,873     |   | $ | 63,685 |   |

 

Undistributed earnings of foreignsubsidiaries included in continuing operations were approximately $ 19.0million and $17.7 million at June 30, 2005 and December 31, 2004,respectively.  No taxes have beenprovided on the undistributed earnings as they are considered to be permanentlyreinvested.

 

**12.****                               WARRANTYLIABILITY**

 

TheCompany offers various product warranties for hardware sold to itscustomers.  The specific terms and conditions of the warranties varydepending upon the customer and the product sold.  Factors that affect theCompany’s warranty liability include 

 

12

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numberof products sold, historical and anticipated rates of warranty claims and costper claim.  The Company accrues for estimated warranty costs as sales aremade and periodically assesses the adequacy of its recorded warranty liabilityand adjusts the amount as necessary.

 

Changesto the Company’s warranty liability, which is reported as a component of otheraccrued expenses and liabilities in the accompanying condensed consolidatedbalance sheet during the six months ended June 30, 2004 are summarized asfollows:

 
| ** **                                        | ** ** | **(In  thousands)** | ** ** |
|---------------------------------------------------|------------|---------------------|------------|
| Balance at December 31, 2004                 |       | $                   | 180        |   |
| Warranties issued                                 |       | 155                 |       |
| Claims paid/settlements                           |       | (83                 | )          |
| Changes in liability for pre-existing  warranties |       | —              |       |
| Balance at June 30, 2005                     |       | $                   | 252        |   |

 

**13.****                               COMPREHENSIVELOSS**

 

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

 
| ** **                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                               | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(In thousands)**                   | ** ** | **(In thousands)**                 | ** ** |
| Net loss                                 |       | $                                    | (4,988     | )                                  | $          | (1,679 | ) | $ | (6,432 | ) | $ | (2,471 | ) |
| Foreign currency translation adjustments |       | (964                                 | )          | (151                               | )          | (1,270 | ) | 312 |   |
| Total comprehensive loss                 |       | $                                    | (5,952     | )                                  | $          | (1,830 | ) | $ | (7,702 | ) | $ | (2,159 | ) |

 

13

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**14.****                               BUSINESS SEGMENT DATA**

 

The Company segments its operations based ongeographical areas (North American Operations (“NAOPS”) and European Operations (“EUOPS”)) and productlines (Computer and Network Services (“CNS”)). EUOPS offers similar products asNAOPS and consists primarily of operations throughout the world excluding theUnited States and Canada.  The Companyrecently realigned its reporting structure and began reporting under the newalignment in the first quarter of 2005. Under this new structure, NAOPS includes the operations of the Company’sCanadian operations and the operations of Plexus® products (“Plexus”) that werepreviously reported in International Solutions. The operations of Plexus and Canada are not material to EUOPS or toNAOPS.  Under the new structure thecomposition of CNS remains unchanged. Prior period information has been reclassified to reflect the newalignment.

 
| ** **                                     | ** ** | **North   American   Operations** | ** ** | **Computer   & Network   Services** | ** ** | **European   Operations** | ** ** | **Corp/Elims** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-----------------------------------|------------|----------------------------------------------|------------|---------------------------|------------|----------------|------------|-----------|------------|
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| For the three months ended  June 30, 2005 |       |                              |       |                                         |       |                      |       |           |       |      |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| Revenue from external customers                |       | $                                 | 27,080     |                                         | $          | 30,176                    |       | $              | 27,178     |      | $          | — |   | $ | 84,434 |   |
| Intersegment revenue                           |       | 1,578                             |       | —                                       |       | 1,126                     |       | (2,704         | )          | —    |       |
| Segment gross profits                          |       | 9,181                             |       | 1,903                                        |       | 9,906                     |       | (28            | )          | 20,962    |       |
| Segment operating income (loss)                |       | 3,125                             |       | 624                                          |       | 3,612                     |       | (6,226         | )          | 1,135     |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| For the three months ended  June 30, 2004 |       |                              |       |                                         |       |                      |       |           |       |      |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| Revenue from external customers                |       | $                                 | 34,381     |                                         | $          | 33,735                    |       | $              | 31,703     |      | $          | — |   | $ | 99,819 |   |
| Intersegment revenue                           |       | 1,422                             |       | —                                       |       | 1,159                     |       | (2,581         | )          | —    |       |
| Segment gross profits                          |       | 9,075                             |       | 6,337                                        |       | 10,537                    |       | 176            |       | 26,125    |       |
| Segment operating income (loss)                |       | 2,725                             |       | 3,779                                        |       | 4,625                     |       | (3,392         | )          | 7,737     |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| For the six months  endedJune 30, 2005    |       |                              |       |                                         |       |                      |       |           |       |      |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| Revenue from external customers                |       | $                                 | 57,007     |                                         | $          | 61,332                    |       | $              | 54,730     |      | $          | — |   | $ | 173,069 |   |
| Intersegment revenue                           |       | 3,062                             |       | —                                       |       | 2,988                     |       | (6,050         | )          | —    |       |
| Segment gross profits                          |       | 19,582                            |       | 5,480                                        |       | 20,150                    |       | (39            | )          | 45,173    |       |
| Segment operating income (loss)                |       | 7,951                             |       | 2,687                                        |       | 7,263                     |       | (11,850        | )          | 6,051     |       |
| Segment identifiable assets                    |       | 79,009                            |       | 27,792                                       |       | 42,236                    |       | 46,467         |       | 195,504   |       |
| Capital appropriations                         |       | 2,050                             |       | 759                                          |       | 806                       |       | 1,276          |       | 4,891     |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| For the six months  endedJune 30, 2004    |       |                              |       |                                         |       |                      |       |           |       |      |       |
|                                           |       |                              |       |                                         |       |                      |       |           |       |      |       |
| Revenue from external customers                |       | $                                 | 66,968     |                                         | $          | 65,351                    |       | $              | 56,584     |      | $          | — |   | $ | 188,903 |   |
| Intersegment revenue                           |       | 3,029                             |       | —                                       |       | 2,406                     |       | (5,435         | )          | —    |       |
| Segment gross profits                          |       | 19,425                            |       | 8,719                                        |       | 19,328                    |       | (244           | )          | 47,228    |       |
| Segment operating income (loss)                |       | 6,555                             |       | 3,738                                        |       | 7,607                     |       | (6,196         | )          | 11,704    |       |
| Segment identifiable assets                    |       | 78,436                            |       | 24,784                                       |       | 54,243                    |       | 80,880         |       | 238,343   |       |
| Capital appropriations                         |       | 1,457                             |       | 1,107                                        |       | 769                       |       | 466            |       | 3,799     |       |

 

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

 

**SERIES A PREFERRED STOCK**

 

The Company allocated the proceeds from its Series Apreferred stock issuance based upon the relative fair value of the preferredstock and warrants issued.  The relateddiscount was being accreted over a period of 8 years through March 31,2004, when the mandatory redemption provision was removed from the Series APreferred Stock.  Effective January 1,2005, the Series A Preferred Stock agreement was amended to eliminate thedividends payable on the Series A Preferred Stock.  As a result, no dividends were accrued duringthe six months ended June 30, 2005. As of June 30, 2005, the stated value of the Series A preferred stock, includingaccumulated but unpaid dividends, was $201.32 per share.

 

14

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**SERIES B PREFERRED STOCK**

 

Effective January 1, 2005, the Series BPreferred Stock agreement was amended to eliminate the dividends payable on theSeries B Preferred Stock.  As aresult, no dividends were accrued during the six months ended June 30,2005.  As of June 30,2005, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $380.63 pershare.

 

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

 

On December 16, 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment*.*” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123R eliminates theability to account for share-based compensation transactions using AccountingPrinciples Board Opinion No. 25 and generally requires that suchtransactions be accounted for using a fair-value-based method.  The Company is required to adopt SFAS No. 123(R)in fiscal 2006, beginning January 1, 2006. The Company is currently assessing the final impact of this standard onthe company’s consolidated results of operations, financial position, and cashflows. This assessment includes evaluating option valuation methodologies andassumptions as well as potential changes to the Company’s compensation strategies.

 

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

 

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

 

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

 

The Jobs Creation Act also creates a temporary incentive for U.S.corporations to repatriate accumulated income earned abroad by providing an 85percent dividends received deduction for certain dividends from controlledforeign corporations. The deduction is subject to a number of limitations anduncertainty remains as to how to interpret numerous provisions in the Act. FSP109-2 addresses when to reflect in the financial statements the effects of theone-time tax benefit on the repatriation of foreign earnings. Under SFAS No. 109,companies are normally required to reflect the effect of new tax law changes inthe period of enactment. FSP 109-2 provides companies additional time todetermine the amount of earnings, if any, that they intend to repatriate underthe Jobs Creation Act’s provisions.  Asof June 30, 2005, the Company was not in a position to decide on whether,and to what extent, foreign earnings that have not yet been remitted to theU.S. may be repatriated.

 

**17. SUBSEQUENT EVENTS**

 

None

 

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

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

*This Quarterly Report on Form 10-Q, includingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and Quantitative and Qualitative Disclosure About Market Riskcontains forward-looking statements as that term is defined in the PrivateSecurities Litigation Reform Act of 1995 (the “PSLRA”) that involve risks anduncertainties, as well as assumptions that, if they never materialize or proveincorrect, could cause the results of BancTec, Inc. and its consolidatedsubsidiaries (the “Company”) to differ materially from those expressed orimplied by such forward-looking statements. All statements other thanstatements of historical fact are statements that could be deemedforward-looking statements, including any projections of earnings, revenues, orother financial items; any statements of the plans, strategies, and objectivesof management for future operations; any statements concerning proposed newproducts, services, or developments; any statements regarding future economicconditions or performance; statements of belief and any statement ofassumptions underlying any of the foregoing. The risks, uncertainties andassumptions referred to above include the ability of the Company to retain andmotivate key employees; the timely development, production and acceptance ofproducts and services and their feature sets; the challenge of managing assetlevels, including inventory; the flow of products into third-party distributionchannels; the difficulty of keeping expense growth at modest levels whileincreasing revenues; and other risks that are described from time to time inthe Company’s Securities and Exchange Commission reports, including but notlimited to the items discussed in “Factors Affecting the Company’s Business andProspects” set forth in this report, and items described in the Company’s otherfilings with the Securities and Exchange Commission. The Company undertakes noobligation to update or revise forward-looking statements to reflect changes inassumptions, the occurrence of unanticipated results or changes to futureoperating results over time.*

* *

**Overview**

 

The Company believes severalfactors continued to create a challenging and competitive sales andcost-containment environment during the six months ended June 30,2005.  These factors include: generaleconomic conditions and reduced corporate customer technology spending; ongoingcompetitive pressures; an ongoing planned change in revenue mix within theCompany’s North American Operations (“NAOPS”) and European Operations (“EUOPS”)segments; and a highly leveraged financial position.  The change in revenue mix is partially aresult of trends in payment processing, including truncation, which impactsdomestic and international markets. Additionally, during the six months ended June 30, 2005, the NAOPSand EUOPS segments experienced revenue declines in the maintenance business,the duration of which the Company cannot predict.

 

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

 

**RESULTS OF OPERATIONS**

 

**Comparison of Three Months Ended June 30,2005 and Three Months Ended June 30, 2004**

 

Consolidated revenue of $84.4 million for thethree months ended June 30, 2005 decreased by $15.4 million or 15.4% fromthe comparable prior-year period.  TheNorth American Operations (“NAOPS”) revenue decrease of $7.3 million waspartially related to a decline in maintenance revenue due to the Company’sinstalled products reaching the end of their useful lives and from increasedcompetition.  The Company expects thesetrends to continue on these end-of-life products.  In addition, a decline in revenues related tothe sale and installation of hardware and software products was primarilyrelated to a weak market for payments solutions due to market trends, includingreduced check volume, check truncation, and the recent passage of Check21.  Decreases in European Operations (“EUOPS”)of $4.5 million are the result of decreased sales in Europe of ECM solutionscompared with the prior year’s period offset by the impact of the weakeneddollar on the conversion of revenue stated in foreign currencies.  Although Computer & Network Services(“CNS”) revenue decreased $3.5 million with the comparable prior-year period,revenue of $4.3 million was recorded in the prior-year period reflecting anadjustment arising out of a change in accounting estimate related to deferredrevenue.  Additional revenue decreasesresulted from pricing decreases, domestic competitive pressure, and decreasedvolume under certain maintenance programs, partially offset by revenueincreases from the expansion by CNS of operations in Europe.  Factors expected to 

 

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impact future revenue includecorporate-customer spending for large systems-solutions, the continued impactsof check truncation, on-going competitive pressures, and fluctuations ininternational currencies.

 

Consolidated gross profit of $21.0 milliondecreased by $5.1 million or 19.5% from the comparable prior-year period.  Gross profit increased by $0.1 million or1.1% for NAOPS, decreased by $4.4 million or 69.8% for CNS and decreased by$0.6 million or 5.7% for EUOPS.  Althoughrevenue decreased in NAOPS, the impact to gross profit was offset by anincrease in the NAOPS gross profit percentage as a result of ongoingcost-containment efforts aimed at improving efficiency in the maintenanceorganization. The NAOPS gross margin percentage increased from 25.4% to32.1%.  Decreases in EUOPS gross profitresulted primarily from decreased revenue offset by an increase in gross profitmargin and the impact of currency conversion. The EUOPS gross margin percentage increased from 31.9% to 35.0%.  Continued efforts to provide provendeliverables as well as targeted new offerings, including EDMsolutions, archive solutions and hardware enhancements, which, along with ongoing cost-containment efforts, allowed forcost reductions to strengthen the EUOPS gross profit.  CNS’ gross profit percentagedecreased from 18.7% to 6.3%, primarily due to the revenue adjustment of $4.3million recorded in the prior-year period reflecting a change in accountingestimate on deferred revenue.  CNSis the major component in the maintenance and other services category on theConsolidated Statements of Operations, and therefore is a significantcontributing factor in the increased gross profit in the maintenance and otherservices category.

 

Operating expenses of $19.8 million increased$1.4 million compared to the prior-year period. Product-development expenses increased by $0.5 million or 24.0%primarily due to the timing of research projects.  Selling, general and administrative expenses(“SG&A”) increased by $0.9 million or 5.5% primarily due toincreased marketing activities related to an expansion and refocus of thecorporate marketing strategy, increased sales expense resulting from anexpansion of the sales force to support new product strategies, and increaseddepreciation expense.

 

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

 

Sundry items resulted in a net loss for the three months ended June 30,2005, of $0.2 million compared to a net loss of $1.5 million during thecomparable prior-year period.  Foreignexchange losses are the primary cause of the net loss for the three monthsended June 30, 2005.  The $1.5million loss recorded for the comparable prior-year period was the result ofthe write-down of the Company’s investment in the stock of Servibanca S.A. tofair market value at June 30, 2004.

 

An income tax provision of $1.3 million for the three months ended June 30, 2005 is compared to a correspondingprior-year period income tax provision of $3.3 million.  The income tax provision for the current-yearperiod related primarily to income from the Company’s internationalsubsidiaries.  The Company’s effectivetax rate was approximately (36.4%) for the three months ended June 30, 2005 as compared to 204.2% for thecorresponding prior-year period.

 

**Comparison of Six Months Ended June 30,2005 and Six Months Ended June 30, 2004**

 

Consolidated revenue of $173.1 million forthe six months ended June 30, 2005 decreased by $15.8 million or 8.4% fromthe comparable prior-year period.  TheNorth American Operations (“NAOPS”) revenue decrease of $10.0 million waspartially related to a decline in maintenance revenue due to the Company’sinstalled products reaching the end of their useful lives and from increasedcompetition.  The Company expects thesetrends to continue on these end-of-life products.  In addition, a decline in revenues related tothe sale and installation of hardware and software products was primarilyrelated to a weak market for payments solutions due to market trends, includingreduced check volume, check truncation, and the recent passage of Check 21.  Decreases in European Operations (“EUOPS”) of$1.9 million are the result of decreased sales in Europe of ECM solutionscompared with the prior year’s period offset by the impact of the weakeneddollar on the conversion of revenue stated in foreign currencies.  A decrease in Computer & NetworkServices (“CNS”) of $4.1 million resulted from the revenue adjustment of $4.3million in the prior-year period, reflecting a change in accounting estimaterelated to deferred revenue.  This waspartially offset by revenue increases from the expansion by CNS of operationsin Europe.  Factors expected to impactfuture revenue include corporate-customer spending for large systems-solutions,the continued impacts of check truncation, on-going competitive pressures, andfluctuations in international currencies.

 

Consolidated gross profit of $45.2 milliondecreased by $2.0 million or 4.2% from the comparable prior-year period.  Gross profit increased by $0.2 million or1.0% for NAOPS, decreased by $3.2 million or 36.8% for CNS and increased by$0.9 million or 4.7% for EUOPS.  Althoughrevenue decreased in NAOPS, the impact to gross profit was offset by anincrease in the NAOPS gross profit percentage as a result of ongoingcost-containment efforts aimed at improving efficiency in the maintenanceorganization. The NAOPS gross margin percentage increased from 27.7% to32.6%.  Increases in EUOPS gross profitresulted from an improved gross margin percentage, despite decreasedrevenues.  The EUOPS gross marginpercentage increased from 32.7% to 35.0%. Continued efforts to provide proven deliverables as well as targeted newofferings, including EDM solutions, archive solutions andhardware enhancements, which, alongwith ongoing cost-containment efforts, allowed for cost reductions tostrengthen the EUOPS gross profit.  CNS’ gross profit percentage decreased from13.3% to 9.0%, primarily due to the revenue adjustment of $4.3 million recordedin the prior-year period reflecting a change in accounting estimate on deferredrevenue.  CNS is the majorcomponent in the maintenance and other services category on the ConsolidatedStatements of Operations, and therefore is a significant contributing factor inthe increased gross profit in the maintenance and other services category.

 

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Operating expenses of $39.1 million increased$3.6 million compared to the prior-year period. Product-development expenses increased by $0.2 million or 4.3% primarilydue to the timing of research projects. Selling, general and administrative expenses (“SG&A”) increased by$3.3 million or 10.6% primarily due to increased marketingactivities related to an expansion and refocus of the corporate marketingstrategy, increased sales expense resulting from an expansion of the salesforce to support new product strategies, and increased depreciation expense.

 

Interest expense for the sixmonths ended June 30, 2005 of $9.5 million decreased $0.1 million from thecomparable prior-year period.

 

Sundry items resulted in a net loss for the six months ended June 30,2005, of $0.7 million compared to a net loss of $2.0 million for the comparableprior-year period.  Foreign exchangelosses of $0.7 million were recorded for the six months ended June 30,2005, compared with foreign exchange losses of $0.5 million and the $1.5million write down of the Company’s investment in the stock of Servibanca S.A.to fair market value in the comparable prior year period.

 

An income tax provision of $2.7 million for the six months ended June 30, 2005 is compared to a correspondingprior-year period income tax provision of $2.9 million.  The income tax provision for the current-yearperiod related primarily to income from the Company’s internationalsubsidiaries.  The Company’s effectivetax rate was approximately (71.5%) for the six months ended June 30, 2005 as compared to 650.3% for thecorresponding prior-year period.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The Company’s working capitaland capital expenditure requirements are generally provided by cash and cashequivalents, funds available under the Company’s revolving credit agreement, asdiscussed below, which will mature May 30, 2006, and by internallygenerated funds from cash flows from operations. Funds availabilityunder the revolving credit agreementis determined by a borrowing-base formula equal to a specified percentage ofthe value of the Company’s eligible accounts receivable, inventory and pledgedcash.  General economic conditions, the current weakness in demand for theCompany’s systems solutions products and the requirement to obtain performancebonds or similar instruments could have a material impact on the Company’sfuture liquidity.  The Company believes,however, that these sources will be sufficient to support operations andcapital expenditure needs during the next twelve months.

 

The Company’s cash and cash equivalentstotaled $36.9 million at June 30, 2005, compared with $51.5 million at December 31,2004. Working capital decreased $6.3 million during the six months ended June 30,2005 to working capital of $5.2 millioncompared to working capital of $11.5 million at December 31, 2004.  The change in working capital included acurrent liability decrease of $10.2 million resulting from $12.4 milliondecrease in deferred revenue and maintenance contract deposits, anincrease in accrued liabilities of $2.0 million, an accounts receivable decrease of $0.3 million, an inventory decrease of$3.0 million and a prepaid expense increase of $1.1 million.

 

During the six months ended June 30,2005, the Company relied primarily on cashreserves to fund operations. At June 30, 2005, the Company had available $19.5 million ofborrowing capacity under the Revolver, of which the Company can draw$15.5 million.

 

Operating activities used $10.0 million ofcash and provided $4.9 million of cash in the six months ended June 30,2005 and 2004, respectively, a decrease of$14.9 million.  The net loss increased$3.9 million from the prior-year period. In addition, cash generated by changes in working capital assets andliabilities was $9.5 million less than in the prior-year period.

 

Investing activities used net cash of $3.4million and $3.2 million in the six months ended June 30,2005 and 2004, respectively. Both uses ofcash related to purchases of property, plant and equipment.

 

Financing activities used $0.3 million and$0.6 million for each of the six months ended June 30, 2005 and 2004, respectively.  Both uses of cash related primarily to thereduction of the Company’s debt.

 

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

 

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

 

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**Revolving Credit Facility.**The Company has a revolving credit facility (the “Revolver”)provided by Heller Financial, Inc. (“Heller”), which will mature on May 30,2006.  Effective May 7, 2003,the Company and Heller entered into an amendment to the Revolver which reducedthe committed amount from $60 million to $40 million, while increasing theletter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.  Fundsavailability under the Revolver is determined by a borrowing-base formula equalto a specified percentage of the value of the Company’s eligible accountsreceivable, inventory and pledged cash. At June 30, 2005, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $0.3million.  The balance remaining under theRevolver that the Company can draw was $15.5 million at June 30, 2005($19.5 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on theunused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’soption, either (1) 1.25% over prime or (2) 2.75% over LIBOR.  Under an amendment effective September 1,2003, the interest rate margins over prime and LIBOR may be increased by 0.25%increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0and (2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by0.25% increments when the fixed charge coverage ratio is greater than (1) 1.75to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of0.75%).  The interest rate was remeasuredas of the effective date of September 1, 2003 under this amendment.  At June 30, 2005, the Company’s weightedaverage rate on the Revolver was 8.0% under the prime option.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at June 30, 2005 of $0.4 million represents cashpledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties andcovenants, including financial covenants as to maximum capital expenditures,minimum fixed charge coverage ratio and minimum average borrowingavailability.  Effective December 31,2004, the Company and Heller amended the loan and security agreement todecrease the minimum fixed charge coverage ratio at December 31, 2004 to1.1 to 1.0.  Effective March 31,2005, the loan and security agreement was further amended to add a triggeringevent for the fixed charged coverage ratio covenant.  No fixed charge coverage ratio covenantapplies when cash balances exceed $20 million and the outstanding balance onthe revolver is less than $250,000.  Ifeither of these conditions is not met, then the fixed charge covenant ratiorequirement becomes 1.1 to 1.0.  At June 30,2005, the Company was in compliance with all covenants under the Revolver.

 

**Senior Notes**. In August 1998, the Company exchanged thepublic Senior Notes (the “Senior Notes”) for the notes sold in a May 1998 Rule 144Aprivate offering. Interest is fixed at 7.5% and is due and payable insemi-annual installments, which began December 1, 1998. The Senior Notesmature on June 1, 2008.  The SeniorNotes contain covenants placing limitations on the Company’s ability to permitsubsidiaries to incur certain debts, incur certain loans, and engage in certainsale and leaseback transactions.

 

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

 

**Preferred Stock — Series A**.****The Companyallocated the proceeds from its Series A preferred stock issuance basedupon the relative fair value of the preferred stock and warrants issued.  The related discount was being accreted overa period of 8 years through March 31, 2004, when the mandatory redemptionprovision was removed from the Series A Preferred Stock.  Effective January 1, 2005, the Series APreferred Stock agreement was amended to eliminate the dividends payable on theSeries A Preferred Stock.  As aresult, no dividends were accrued during the six months ended June 30,2005.  As of June 30, 2005, the stated value of the Series A preferredstock, including accumulated but unpaid dividends, was $201.32 per share.

 

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

 

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

 

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

In the normal course of business, the Company enters into variouscontractual and other commercial commitments that impact, or could impact, theliquidity of operations. The following table outlines the commitments at June 30,2005:

 
| ** **                         | ** ** | **Total   Amounts** | ** ** | **Less than****   1 Year** | ** ** | **1-3****   Years** | ** ** | **4-5****   Years** | ** ** | **Over 5   Years** | ** ** |
|------------------------------------|------------|---------------------|------------|---------------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------|------------|
| ** **                         | ** ** | **(In Millions)**   | ** ** |
| Long-term debt                     |       | $                   | 197.8      |                            | $          | —                   |       | $                        | 94.0       |               | $          | 103.8 |   | $ | — |   |
| Capital leases                     |       | 0.2                 |       | 0.1                             |       | 0.1                      |       | —                   |       | —             |       |
| Purchase Obligations               |       | 2.0                 |       | 0.7                             |       | 1.3                      |       | —                   |       | —             |       |
| Operating leases  (non-cancelable) |       | 12.8                |       | 4.8                             |       | 5.5                      |       | 1.6                      |       | 0.9                |       |
| Total Contractual                  |       | 212.8               |       | 5.6                             |       | 100.9                    |       | 105.4                    |       | 0.9                |       |
|                               |       |                |       |                            |       |                     |       |                     |       |               |       |
| Unused lines of credit             |       | $                   | 19.5       |                            | $          | 19.5                     |       | $                        | —     |               | $          | — |   | $ | — |   |
| Standby letters of credit          |       | 0.3                 |       | 0.3                             |       | —                   |       | —                   |       | —             |       |
| Total Commercial                   |       | $                   | 19.8       |                            | $          | 19.8                     |       | $                        | —     |               | $          | — |   | $ | — |   |

 

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

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

On December 16, 2004, the FASB issued SFAS No. 123R, “Share-BasedPayment*.*” SFAS No. 123R addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123R eliminates theability to account for share-based compensation transactions using AccountingPrinciples Board Opinion No. 25 and generally requires that suchtransactions be accounted for using a fair-value-based method.  The Company is required to adopt SFAS No. 123(R)in fiscal 2006, beginning January 1, 2006. The Company is currently assessing the final impact of this standard onthe company’s consolidated results of operations, financial position, and cashflows. This assessment includes evaluating option valuation methodologies andassumptions as well as potential changes to the Company’s compensationstrategies.

 

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

 

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

 

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

 

The Jobs Creation Act also creates a temporary incentive for U.S.corporations to repatriate accumulated income earned abroad by providing an 85percent dividends received deduction for certain dividends from controlledforeign corporations. The deduction is subject to a number of limitations anduncertainty remains as to how to interpret numerous provisions in the Act. FSP109-2 addresses when to reflect in the financial statements the effects of theone-time tax benefit on the repatriation of foreign earnings. Under SFAS 

 

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No. 109, companies are normally required to reflect the effect ofnew tax law changes in the period of enactment. FSP 109-2 provides companiesadditional time to determine the amount of earnings, if any, that they intendto repatriate under the Jobs Creation Act’s provisions.  As of June 30, 2005, the Company was notin a position to decide on whether, and to what extent, foreign earnings thathave not yet been remitted to the U.S. may be repatriated.

 

**FACTORS AFFECTING THE COMPANY’S BUSINESS AND PROSPECTS**

 

Information provided by the Company in this Quarterly Report on Form 10-Qand other documents filed with the Securities and Exchange Commission include “forward-looking”information, as that term is defined in the Private Securities LitigationReform Act of 1995 (the “PSLRA”). All statementsother than statements of historical fact are statements that could be deemedforward-looking statements.  TheCompany cautions investors that there can be no assurance that actual resultsor business conditions will not differ materially from those projected orsuggested in such forward-looking statements as a result of numerous factorsbeyond the Company’s control. The Company undertakes no obligation to update orrevise forward-looking statements to reflect changes in assumptions, theoccurrence of unanticipated results or changes to future operating results overtime. The following is a description of some of the important factors that maycause the actual results of the Company’s operations in future periods todiffer materially from those currently expected or desired.

 

***General Economic Conditions***

 

The Company’s business partially depends on general economic andbusiness conditions. The Company’s sales are to businesses in a wide variety ofindustries, including banking, financial services, insurance, health care andhigh technology, and to governmental agencies. General economic conditions that cause customers to reduce or delaytheir investments in products and solutions, such as those offered by theCompany, could have a material adverse effect on the Company, including itsbusiness, operating results, financial condition and prospects.

 

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

 

***Technological Changes and Product Transitions***

 

The Company’s industry is characterized by continuing improvement intechnology, which results in the frequent introduction of new products, shortproduct life cycles and continual improvement in product price/performancecharacteristics.  The Company mustincorporate these new technologies into its products and solutions in order toremain competitive. There can be no assurance that the Company will be able tocontinue to manage technological transitions. A failure on the part of the Company to effectively manage thesetransitions of its product lines to new technologies on a timely basis couldhave a material adverse effect on the Company. In addition, the Company’s business depends on technology trends in itscustomers’ businesses.  Many of theCompany’s traditional products depend on the efficient handling of paper-basedtransactions.  To the extent thattechnological changes impact the future volume of paper transactions, theCompany’s traditional business may be adversely impacted.

 

***Dependence on Suppliers***

 

The Company’s solutions products depend on the quality of componentsthat are procured from third-party suppliers. Reliance on suppliers, as well as industry supply conditions, generallyinvolves several risks, including the possibility of defective parts (which canadversely affect the reliability and reputation of the Company’s products), ashortage of components and reduced control over delivery schedules (which canadversely affect the Company’s manufacturing efficiencies) and increases incomponent costs (which can adversely affect the Company’s profitability).

 

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

 

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

 

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

 

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***International Activities***

 

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

 

***Fluctuations in Operating Results***

 

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

 

***Product Development Activities***

 

The strength of the Company’s overall business depends in part on theCompany’s ability to develop products and solutions based on new or evolvingtechnology and the market’s acceptance of those products.  There can be no assurance that the Company’sproduct development activities will be successful, that new technologies willbe available to the Company, that the Company will be able to delivercommercial quantities of new products in a timely manner, that those productswill adhere to generally accepted industry standards or that products willachieve market acceptance.  Many of theCompany’s customers use its products in highly regulated or technologicallydemanding industries.  As a result ofproducts introduced by the Company’s competitors, generally accepted industrystandards can change rapidly in ways that are beyond the control of theCompany.

 

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

 

The Company utilizes long-term fixed rate andshort-term variable rate borrowings to finance the working capital and capitalrequirements of the business. At December 31, 2004 and 2003, the Companyhad outstanding Senior Notes, due in 2008, of $94.0 million, with a fixedinterest rate of 7.5%. At December 31, 2004 and 2003, the Company also hadthe Sponsor Note, due 2009, with a balance of $103.8 million. The Sponsor Notebears interest at a fixed rate of 10.0%. The Company utilizes a revolving credit facility to support workingcapital needs. The interest rate on loans under the Revolver is,at the Company’s option, either (1) 1.25% over prime or (2) 2.75%over LIBOR.  Although no actual balances were outstanding under the Revolver at June 30,2005, assuming $1.0 million in borrowings under the Revolver, a one hundredbasis point change in the bank’s prime or LIBOR rate would impact net interestexpense by $10,000 over a twelve-month period.

 

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

 

**ITEM 4. CONTROLS AND PROCEDURES.**

 

As of the end of the period covered by this report, June 30, 2005,the Chief Executive Officer and the Chief Financial Officer of the Company,with the participation of the Company’s management, evaluated the effectivenessof the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14.  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.  The Company will continue to evaluatedisclosure controls on an ongoing basis.

 

Disclosure controls and procedures, no matter how well designed andimplemented, can provide only reasonable assurance of achieving an entity’sdisclosure objectives.  The likelihood ofachieving such objectives is affected by limitations inherent in disclosure controlsand procedures.  These include the factthat human judgment in decision-making can be faulty and that breakdowns ininternal control can occur because of human failures such as simple errors ormistakes or intentional circumvention of the established process.  The Company’s disclosure controls andprocedures are designed to provide reasonable assurance of achieving theirobjectives, and the Chief Executive Officer and Chief Financial Officer believethat the Company’s disclosure controls and procedures are effective at thatreasonable assurance level.

 

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

 

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**BANCTEC, INC.**

**PART II**

**OTHER INFORMATION**

 

**ITEM 1. Legal Proceedings**

** **

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

 

**ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds**

** **

None

 

**ITEM 3. Defaults Upon Senior Securities**

** **

None

 

**ITEM 4.  Submission of Matters toa Vote of Security Holders**

 

None

 

**ITEM 5. Other Information**

** **

None

 

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

 

(a)          Exhibits:

 

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

 

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

 

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

 

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

 

(b)         Reports on Form 8-K:

 

None

 

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**SIGNATURES**

 

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

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

 

 

Dated: August 10, 2005

 

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