**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

| **ý** |   | **Quarterly  Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30, 2003**

 

**OR**

 

| **o** |   | **Transition  Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934** |
|-------|--------|-----------------------------------------------------------------------------------------------|

 

**Commission File Number 0-9859**

 

**BANCTEC, INC.**

(Exact name of registrantas specified in its charter)

 

| **DELAWARE**                                                    |   | **75-1559633**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **2701 E. Grauwyler Road, Irving,  Texas**                      |   | **75061**                             |
| (Address of principal  executive offices)                       |   | (Zip Code)                            |
|                                                            |   |                                  |
| **(972) 579-6000**                                              |
| (Registrant’s telephone  number, including area code)      |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90days.           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  oNo  ý

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

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

 

 

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**PART I**

**FINANCIAL INFORMATION**

**ITEM 1.  Financial Statements**

**BANCTEC, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

** **
|                                                                                                                              |   | **June 30,  2003** |    | **December 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                                                                                                              |   | **(Unaudited)**    |    |                   |   |
| CURRENT ASSETS:                                                                                                                   |   |               |    |                   |   |
| Cash and cash equivalents, including restricted cash  of $27,979 and $88 at June 30, 2003 and December 31, 2002                   |   | $                  | 52,977  |                   | $      | 31,595 |   |
| Accounts receivable, less allowance for doubtful  accounts of  $1,734 and $2,216 at  June 30, 2003 and December 31, 2002          |   | 51,867             |    | 60,891                 |   |
| Inventories, net                                                                                                                  |   | 27,219             |    | 25,528                 |   |
| Prepaid expenses                                                                                                                  |   | 6,975              |    | 5,177                  |   |
| Other current assets                                                                                                              |   | 206                |    | 334                    |   |
|                                                                                                                              |   |               |    |                   |   |
| Total current assets                                                                                                              |   | 139,244            |    | 123,525                |   |
|                                                                                                                              |   |               |    |                   |   |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                                                |   | 51,739             |    | 54,782                 |   |
|                                                                                                                              |   |               |    |                   |   |
| OTHER ASSETS:                                                                                                                     |   |               |    |                   |   |
| Goodwill                                                                                                                          |   | 41,476             |    | 41,476                 |   |
| Other assets                                                                                                                      |   | 10,830             |    | 11,612                 |   |
|                                                                                                                              |   |               |    |                   |   |
| Total other assets                                                                                                                |   | 52,306             |    | 53,088                 |   |
| TOTAL ASSETS                                                                                                                      |   | $                  | 243,289 |                   | $      | 231,395 |   |
|                                                                                                                              |   |               |    |                   |   |
| CURRENT  LIABILITIES:                                                                                                             |   |               |    |                   |   |
| Current obligations  under capital leases                                                                                         |   | $                  | 1,071   |                   | $      | — |   |
| Trade accounts  payable                                                                                                           |   | 12,702             |    | 12,891                 |   |
| Other accrued  expenses and liabilities                                                                                           |   | 43,493             |    | 46,883                 |   |
| Deferred revenue                                                                                                                  |   | 27,971             |    | 24,107                 |   |
| Maintenance  contract deposits                                                                                                    |   | 54,935             |    | 47,685                 |   |
| Income taxes                                                                                                                      |   | 3,430              |    | 836                    |   |
| Total current  liabilities                                                                                                        |   | 143,602            |    | 132,402                |   |
|                                                                                                                              |   |               |    |                   |   |
| OTHER LIABILITIES:                                                                                                                |   |               |    |                   |   |
| Long-term debt,  less current maturities                                                                                          |   | 197,823            |    | 201,723                |   |
| Non-current  maintenance contract deposits                                                                                        |   | 28,159             |    | 25,933                 |   |
| Other liabilities                                                                                                                 |   | 11,455             |    | 9,881                  |   |
| Total other  liabilities                                                                                                          |   | 237,437            |    | 237,537                |   |
|                                                                                                                              |   |               |    |                   |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                     |   |               |    |                   |   |
|                                                                                                                              |   |               |    |                   |   |
| MANDATORY  REDEEMABLE PREFERRED STOCK-Series A                                                                                    |   | 15,694             |    | 14,856                 |   |
|                                                                                                                              |   |               |    |                   |   |
| STOCKHOLDERS’  DEFICIT:                                                                                                      |   |               |    |                   |   |
| Cumulative  convertible preferred stock - authorized, 1,000,000 shares of $0.01 par value  at June 30, 2003 and December 31, 2002 |   |               |    |                   |   |
| Series B preferred  stock - issued and outstanding,35,520 shares at June 30, 2003 and  December 31, 2002                          |   | 9,388              |    | 8,324                  |   |
| Common stock  authorized, 22,000,000 shares of $0.01 par value atJune 30,  2003 and 32,000,000 shares at December 31, 2002:       |   |               |    |                   |   |
| Common stock-issued  and outstanding17,003,838 shares at June 30, 2003 and December 31,  2002                                     |   | 170                |    | 170                    |   |
| Class A common  stock-issued and outstanding 1,181,946 sharesat June 30,  2003 and December 31, 2002                              |   | 12                 |    | 12                     |   |
| Subscription stock  warrants                                                                                                      |   | 3,726              |    | 3,726                  |   |
| Additional paid-in  capital                                                                                                       |   | 129,133            |    | 131,035                |   |
| Accumulated deficit                                                                                                               |   | (286,689           | )       | (286,846               | )      |
| Accumulated other  comprehensive loss                                                                                             |   | (9,184             | )       | (9,821                 | )      |
| Total stockholders’  deficit                                                                                                 |   | (153,444           | )       | (153,400               | )      |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ DEFICIT                                                                                 |   | $                  | 243,289 |                   | $      | 231,395 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

2

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**BANCTEC, INC.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
|                                                          |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|---------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                          |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
|                                                          |   | **(In thousands)**              |   | **(In thousands)**            |   | **(In thousands)** | ** ** |
| REVENUE                                                       |   |                            |   |                          |   |   |   |   |   |
| Equipment and  software                                       |   | $                               | 38,239 |                          | $      | 33,735 |   | $ | 72,998 |   | $ | 68,920 |   |
| Maintenance and  other services                               |   | 58,804                          |   | 61,839                        |   | 114,797 |   | 123,935 |   |
|                                                          |   | 97,043                          |   | 95,574                        |   | 187,795 |   | 192,855 |   |
| COST OF SALES                                                 |   |                            |   |                          |   |   |   |   |   |
| Equipment and  software                                       |   | 25,497                          |   | 28,564                        |   | 48,715 |   | 55,371 |   |
| Maintenance and  other services                               |   | 46,663                          |   | 46,130                        |   | 91,709 |   | 93,634 |   |
|                                                          |   | 72,160                          |   | 74,694                        |   | 140,424 |   | 149,005 |   |
| Gross profit                                                  |   | 24,883                          |   | 20,880                        |   | 47,371 |   | 43,850 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| OPERATING EXPENSES                                            |   |                            |   |                          |   |   |   |   |   |
| Product development                                           |   | 3,675                           |   | 3,869                         |   | 7,392 |   | 7,172 |   |
| Selling, general  and administrative                          |   | 15,448                          |   | 13,247                        |   | 30,172 |   | 28,663 |   |
|                                                          |   | 19,123                          |   | 17,116                        |   | 37,564 |   | 35,835 |   |
| Income from  operations                                       |   | 5,760                           |   | 3,764                         |   | 9,807 |   | 8,015 |   |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| OTHER INCOME  (EXPENSE):                                      |   |                            |   |                          |   |   |   |   |   |
| Interest income                                               |   | 352                             |   | 52                            |   | 409 |   | 84 |   |
| Interest expense                                              |   | (4,846                          | )      | (7,634                        | )      | (9,668 | ) | (15,226 | ) |
| Sundry, net                                                   |   | 195                             |   | 4,452                         |   | 1,398 |   | 4,002 |   |
|                                                          |   | (4,299                          | )      | (3,130                        | )      | (7,861 | ) | (11,140 | ) |
| INCOME (LOSS) FROM  CONTINUING OPERATIONS BEFORE INCOME TAXES |   | 1,461                           |   | 634                           |   | 1,946 |   | (3,125 | ) |
| INCOME TAX EXPENSE                                            |   | 1,158                           |   | 559                           |   | 1,789 |   | 773 |   |
| INCOME (LOSS) FROM  CONTINUING OPERATIONS                     |   | 303                             |   | 75                            |   | 157 |   | (3,898 | ) |
| INCOME FROM  DISCONTINUED OPERATIONS,NET OF TAX EXPENSE       |   | —                          |   | 880                           |   | — |   | 1,851 |   |
| INCOME (LOSS)  BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE  |   | 303                             |   | 955                           |   | 157 |   | (2,047 | ) |
| CUMULATIVE EFFECT  OF ACCOUNTING CHANGE                       |   | —                          |   | —                        |   | — |   | (6,960 | ) |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| NET INCOME (LOSS)                                             |   | 303                             |   | 955                           |   | 157 |   | (9,007 | ) |
| PREFERRED STOCK  DIVIDENDS AND ACCRETION OF DISCOUNT          |   | (975                            | )      | (829                          | )      | (1,902 | ) | (1,619 | ) |
|                                                          |   |                            |   |                          |   |   |   |   |   |
| NET LOSS APPLICABLE  TO COMMON STOCK                          |   | $                               | (672   | )                             | $      | 126 |   | $ | (1,745 | ) | $ | (10,626 | ) |

 

See notes to unaudited condensed consolidated financial statements.

 

3

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**BANCTEC, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                                                              |   | **Six Months Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                                                              |   | **2003**                      |   | **2002** |   |
|                                                                                                                              |   | **(In thousands)**            |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                                                                              |   |                          |   |   |   |
| Net income (loss)                                                                                                                 |   | $                             | 157    |   | $ | (9,007 | ) |
| Income from discontinued operations                                                                                               |   | —                        |   | 1,851 |   |
| Income (loss) from continuing operations                                                                                          |   | 157                           |   | (10,858 | ) |
| Adjustments to reconcile to cash flows provided by  operations:                                                                   |   |                          |   |   |   |
| Cumulative effect of accounting change                                                                                            |   | —                        |   | 6,960 |   |
| Depreciation and amortization                                                                                                     |   | 10,238                        |   | 12,486 |   |
| Provision for doubtful accounts                                                                                                   |   | (449                          | )      | (1,416 | ) |
| Loss on disposition of property, plant and equipment                                                                              |   | 299                           |   | 478 |   |
| Gain on extinguishment of long-term debt                                                                                          |   | (1,129                        | )      | (2,842 | ) |
| Other non-cash items                                                                                                              |   | 157                           |   | 238 |   |
| Changes in operating assets and liabilities                                                                                       |   |                          |   |   |   |
| Decrease in accounts receivable                                                                                                   |   | 9,473                         |   | 19,366 |   |
| (Increase) decrease in inventories                                                                                                |   | (3,721                        | )      | 4,433 |   |
| Increase in other assets                                                                                                          |   | (421                          | )      | (570 | ) |
| Increase (decrease) in trade accounts payable                                                                                     |   | (189                          | )      | (2,512 | ) |
| Increase (decrease) in deferred revenue &  maintenance contracts deposits                                                     |   | 11,114                        |   | (3,732 | ) |
| Increase (decrease) in other accrued expenses and  liabilities                                                                    |   | 2,234                         |   | (2,248 | ) |
| Cash flows provided by continuing operations                                                                                      |   | 27,763                        |   | 19,783 |   |
| Cash flows provided by discontinued operations                                                                                    |   | —                        |   | 3,100 |   |
| Cash flows provided by operating activities                                                                                       |   | 27,763                        |   | 22,883 |   |
|                                                                                                                              |   |                          |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                                                              |   |                          |   |   |   |
| Purchases of property, plant and equipment                                                                                        |   | (3,255                        | )      | (3,564 | ) |
| Cash flows used in continuing operations                                                                                          |   | (3,255                        | )      | (3,564 | ) |
| Cash flows used in discontinued operations                                                                                        |   | —                        |   | (483 | ) |
| Cash flows used in investing activities                                                                                           |   | (3,255                        | )      | (4,047 | ) |
|                                                                                                                              |   |                          |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                                                              |   |                          |   |   |   |
| Payments of current maturities of long-term debt and  capital lease obligations                                                   |   | (599                          | )      | — |   |
| Payments on long-term borrowing                                                                                                   |   | (2,752                        | )      | (1,783 | ) |
| Payments on short-term borrowings, net                                                                                            |   | —                        |   | (17,040 | ) |
| Debt issuance costs                                                                                                               |   | (95                           | )      | (120 | ) |
| Cash flows used in continuing operations                                                                                          |   | (3,446                        | )      | (18,943 | ) |
| Cash flows used in discontinued operations                                                                                        |   | —                        |   | (3,798 | ) |
| Cash flows used in financing activities                                                                                           |   | (3,446                        | )      | (22,741 | ) |
|                                                                                                                              |   |                          |   |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                                           |   | 320                           |   | 1,895 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                                              |   | 21,382                        |   | (2,010 | ) |
| CASH AND CASH EQUIVALENTS—BEGINNING OF YEAR                                                                                  |   | 31,595                        |   | 22,384 |   |
|                                                                                                                              |   |                          |   |   |   |
| CASH AND CASH EQUIVALENTS—END OF PERIOD                                                                                      |   | $                             | 52,977 |   | $ | 20,374 |   |
|                                                                                                                              |   |                          |   |   |   |
| SUPPLEMENTAL DISCLOSURES INFORMATION:                                                                                             |   |                          |   |   |   |
| Cash paid (refunded) during the period for:                                                                                       |   |                          |   |   |   |
| Interest                                                                                                                          |   | $                             | 10,791 |   | $ | 14,050 |   |
| Taxes                                                                                                                             |   | $                             | (844   | ) | $ | 2,459 |   |
|                                                                                                                              |   |                          |   |   |   |
| Supplemental  schedule of noncash investing and financing transactions:                                                           |   |                          |   |   |   |
| A capital lease  obligation of $2,094 was incurred when the Company entered into a lease for  new computer hardware (See Note 7). |   |                          |   |   |   |

 

See notes to unaudited condensed consolidated financial statements.

 

4

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**BANCTEC, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.             NATUREOF BUSINESS AND BASIS OF PRESENTATION**

 

BancTec, Inc. is aworldwide systems integration and services company with a 30-year history inimaging technology, financial transaction processing and workflow productivityimprovement.  Serving a variety of industries,including banking, financial services, insurance, healthcare, governmentalagencies and others, the Company offers a portfolio of payment and documentprocessing systems and services, workflow and image management softwareproducts, and computer and network support services.

 

The accompanyingunaudited condensed consolidatedbalance sheet June 30, 2003, and the unaudited condensed consolidated statements of operations and cash flows forthe interim periods ended June 30, 2003 and 2002, should be read in conjunctionwith BancTec, Inc. and subsidiaries (“BancTec” or the “Company”) consolidatedfinancial statements and notes thereto in the most recent Annual Report on Form10-K filed with the Securities and Exchange Commission.  As disclosed in the notes to that report,the condensed consolidatedstatements of operations and cash flows for the interim periods ended June 30,2002 have been restated. In the opinion of management, the accompanying condensed consolidated financialstatements contain all material adjustments, consisting principally of normalrecurring adjustments, necessary for a fair presentation of the financialposition and results of operations of the Company. All significant intercompanybalances and transactions have been eliminated in consolidation.

 

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

 

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

 

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

 

Cashand cash equivalents include cash on hand and on deposit, including highlyliquid investments with original maturities of three months or less. Short-terminvestments or similar instruments with original maturities in excess of threemonths and are valued at cost, which approximates market. Restrictedcash at June 30, 2003 of $ 28.0 million represents lockbox cash receipts to beapplied to the outstanding borrowings under the Revolver and cash pledged underthe terms of the Revolver.

 

**Allowance for Doubtful Accounts**

 

The allowance fordoubtful accounts is an estimate prepared by management based on evaluation ofthe collectibility of specific accounts and the overall condition of thereceivable portfolios. The Company analyzes trade receivables, and analyzes historicalbad debts, customer credits, customer concentrations, customercredit-worthiness, current economic trends and changes in customer paymentterms, when evaluating the adequacy of the allowance for doubtful accounts. Theallowance for doubtful accounts is reviewed periodically and adjustments arerecorded as deemed necessary.

 

**Inventories**

 

Inventoriesare valued at the lower of cost or market and include the cost of rawmaterials, labor, factory overhead, and purchased subassemblies. Cost isdetermined using the first-in, first-out and weighted average methods. TheCompany revised its standard costs for manufacturing inventory to effectivelyeliminate the purchasing burden component as of October 1, 2002. At leastquarterly, the Company evaluates the carrying amount of inventory basedon 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, write-downs maybe required. The inventory write-down calculations are reviewed periodically andadditional write-downs are recorded as deemed necessary.  Inventoryreserves establish a new cost basis for inventory and are not reversed infuture periods.

 

**Property, Plant, and Equipment**

Property,plant, and equipment are recorded at cost and are depreciated or amortizedprincipally on a straight-line basis over the estimated useful lives of therelated assets. Estimated useful lives range from three to five years for fieldsupport spare parts, three to eight years for systems and software, five toseven years for machinery and equipment, leasehold improvements, and furnitureand fixtures. Buildings are depreciated over 40 years.

 

5

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**Revenue Recognition**

 

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

 

The Company applies the provisions of Statement of Position 97-2,“Software Revenue Recognition,” as amended by Statement of Position 98-9“Modification of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions” to all transactions involving the sale of softwareproducts and sales of hardware where the software is not incidental. For thosetransactions that involve acceptance certificates, the Company recognizesrevenue upon receipt of the acceptance certificate, or when it can beobjectively demonstrated that acceptance criteria have been met.  For hardware transactions where software isconsidered incidental, or no software is included, revenue is recognized whenthe product has been delivered and all obligations have been fulfilled.

 

TheCompany recognizes revenue from sales of equipment and supplies upon deliveryand transfer of title or upon customer acceptance.

 

Maintenancecontracts are primarily one year in duration and the revenue generated isrecognized ratably over the term of the contract or as service calls areperformed.

 

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 revenue transactionsis fixed or determinable and whether or not collection is reasonably assured.The Company determines whether the fee is fixed or determinable based on thepayment terms associated with the transaction. If a significant portion of afee is due after the normal payment terms, which are generally 30 days frominvoice date, the Company recognizes revenue as the fees are collected. TheCompany assesses collectibility based on a number of factors, including pasttransaction history with the customer and the credit-worthiness of thecustomer. The Company does not request collateral from customers. If theCompany determines that collection of the fee is not reasonably assured, theCompany defers the revenue and recognizes revenue at the time collection becomesreasonably assured, which is generally upon receipt of cash. For all sales, theCompany generally uses either a binding purchase order or signed salesagreement as evidence of an arrangement.

 

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

 

**Research and Development**

 

Researchand development costs are expensed as incurred.

 

**Income Taxes**

 

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

 

Incometaxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases and operating loss and tax credit carryforwards. TheCompany records valuation allowances related to its deferred income tax assetswhen, in the opinion of management, it is more likely than not that someportion or all of the deferred income tax assets will not be realized. Deferredtax assets and liabilities are measured using enacted tax rates expected toapply to taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in income in the period thatincludes the enactment date.

 

**Foreign Currency Translation**

 

Foreignassets and liabilities are translated using the exchange rate in effect at thebalance sheet date, and results of operations are translated using an averagerate for the period. Translation adjustments are accumulated and reported as acomponent of stockholders’ deficit and comprehensive income. Transaction gainsand losses are included in results of operations in “Sundry, net”.

 

6

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**Stock-Based Compensation**

 

TheCompany accounts for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board (“APB No. 25”), Accounting for StockIssued to Employees. The Company has adopted the disclosure requirements ofStatement of Financial Accounting Standards (“SFAS No. 123”), “Accounting forStock-Based Compensation” as specified in SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure—an amendment of SFAS No.123”

 

2000Stock Plan:

 

EffectiveJuly 1, 2000, the Company adopted the 2000 Stock Plan (the Plan), whichprovides for the grant to employees of incentive options, non-qualified stockoptions, and restricted stock awards.  Effective March 19, 2003, all options outstanding under the 2000 StockPlan were cancelled pursuant to an offer to exchange outstanding options datedFebruary 14, 2003.  The offer providesthat new options will be granted not less than six months and one day followingthe closing of the exchange offer.  Thenew options will be granted at the fair market value of the common stock on thedate the date of grant.  Because ofunanticipated accounting consequences, the Company has cancelled plans to issuethe new options and intends to offer an opportunity to rescind the exchangeoffer to all current employees of the Company who surrendered options in theexchange offer.  It is expected thatemployees who rescind will receive options that are substantially identical tothose they surrendered with respect to the number of subject shares, exerciseprice, and vesting schedule.

 

IncentiveOptions. During the year ended December 31, 2000, 1,303,460 incentive optionswere granted by the Company. During 2001, 2002 and 2003, no additionalincentive options were granted.  Under thePlan, incentive options are granted at a fixed exercise price not less than100% of the fair market value of the shares of stock on the date of grant (or110% of the fair market value in certain circumstances). A portion of theincentive options vest over a four-year period at 25% per year beginningJanuary 2, 2001; the remainder vest based on the performance of the Company. Asa part of an employee retention program, vesting of 20.0% of theperformance-based incentive options was accelerated in October 2000.  As described above, these options werecancelled on March 19, 2003.

 

Non-qualifiedstock options. During the year ended December 31, 2000, 377,040 non-qualifiedstock options were granted by the Company. During 2001, 2002 and 2003, noadditional 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 market value of theshares of stock on the date of grant. A portion of the non-qualified optionsvest over a four-year period at 25% per year beginning January 2, 2001; theremainder vest based on the performance of the Company. As a part of anemployee retention program, vesting of 20.0% of the performance-based incentiveoptions was accelerated in October 2000. As described above, these options were cancelled on March 19, 2003.

 

Restrictedstock awards. The amount, if any, to be paid by the award recipient to acquirethe shares of stock pursuant to a restricted stock-award is a fixed exerciseprice equal to, more than, or less than 100% of the fair market value of theshares of stock subject to the award on the date of grant. The restricted stockawards are subject to vesting provisions determined by the Company’s Board ofDirectors. At June 30, 2003, no restricted stock-awards had been granted.

 
|                                        |   | **Incentive  Shares** |   | **Non-qualified  Shares** |   | **Weighted  Average  Exercise  Price** |   |
|---------------------------------------------|--------|-----------------------|--------|---------------------------|--------|----------------------------------------|--------|
| Options  outstanding–December 31, 2001 |   | 632,240               |   | 31,760                    |   | 9.25                                   |   |
| Forfeited                                   |   | (135,000              | )      | —                    |   | 9.25                                   |   |
| Options  outstanding–December 31, 2002 |   | 497,240               |   | 31,760                    |   | 9.25                                   |   |
| Forfeited                                   |   | —                |   | —                    |   | 9.25                                   |   |
| Cancelled                                   |   | (497,240              | )      | (31,760                   | )      | 9.25                                   |   |
| Options  outstanding–June 30, 2003     |   | —                |   | —                    |   | —                                 |   |

 

Underthe intrinsic-value method, compensation expense is recorded only to the extentthat the strike price is less than market price on the measurement date.  There were no stock options granted in 2002or 2003.

 

7

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Thefollowing table illustrates the effect on net income had compensation for theCompany’s stock option plans been determined consistent with SFAS No. 123:

 
|                                                                                                                             |   | **Three Months Ended March 31,** |   | **Six Months Ended June 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|-------------------------------|--------|
|                                                                                                                             |   | **2003**                         |   | **2002**                      |   | **2003** |   | **2002** |   |
| Net Income (loss)  as reported                                                                                                   |   | $                                | 303    |                          | $      | 955 |   | $ | 157 |   | $ | (9,007 | ) |
| Total stock-based employee compensation  benefit (expense) determined under fair-value-based method for all rewards,  net of tax |   | —                           |   | 330                           |   | — |   | 660 |   |
| Pro-Forma net  income (loss)                                                                                                     |   | $                                | 303    |                          | $      | 625 |   | $ | 157 |   | $ | (9,667 | ) |

 

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

 

OnNovember 27, 2002, the Company completed the sale of its wholly-ownedsubsidiary, BancTec Japan (“BTJ”), to JAFCO MBO Co., Ltd. (“JAFCO”) pursuant toa Stock Purchase Agreement dated as of November 27, 2002, between the Companyand JAFCO.  The sale involved two separatetransactions: (1) the purchase by JAFCO of 100% of the outstanding shares ofBTJ for 6.5 billion yen, and (2) a one-time, up-front payment by BTJ to theCompany of 4.0 billion yen under certain distribution and licensingagreements.  Under such agreements, BTJwill continue to operate under the name “BancTec Japan”.  After foreign currency conversions andtransaction costs, the Company received approximately US $82.5 million inaggregate net proceeds.  For financialstatement purposes, the Company treated the sale as a discontinued operationunder SFAS No. 144, and accordingly, financial statement presentation was madein accordance with APB Opinion No. 30. BTJ’s operating results have been segregated and reported asdiscontinued operations in the accompanying consolidated statements of incomeand cash flows, and related notes. Revenue from the discontinued operations of BTJ for the three months andsix months ended June 30, 2002 was $17.6 million and $36.5 million,respectively.  Pretax income from thediscontinued operations of BTJ for the three months and six months ended June30, 2002 was $1.4 million and $3.2 million, respectively.   The assets related to BTJ were previouslyclassified in the International segment.

 

**4.             INVENTORIES**

 

Inventoryconsists of the following:

 
|             |   | **June 30,  2003** |   | **December 31,  2002** |   |
|------------------|--------|--------------------|--------|------------------------|--------|
|             |   | **(In thousands)** |   |
| Raw materials    |   | $                  | 5,481  |                   | $      | 5,374 |   |
| Work-in-progress |   | 11,583             |   | 9,995                  |   |
| Finished goods   |   | 10,155             |   | 10,159                 |   |
|             |   | $                  | 27,219 |                   | $      | 25,528 |   |

 

8

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**5.             PROPERTY,PLANT AND EQUIPMENT**

 

Property,plant and equipment consist of the following:

 
|                                      |   | **June 30,  2003** |   | **December 31,  2002** |   |
|-------------------------------------------|--------|--------------------|--------|------------------------|--------|
|                                      |   | **(In thousands)** |   |
| Land                                      |   | $                  | 2,860  |                   | $      | 2,860 |   |
| Field support spare parts                 |   | 59,200             |   | 58,339                 |   |
| Systems and software                      |   | 66,868             |   | 64,604                 |   |
| Machinery and equipment                   |   | 52,641             |   | 50,053                 |   |
| Furniture, fixtures and other             |   | 24,116             |   | 22,953                 |   |
| Buildings                                 |   | 29,028             |   | 29,006                 |   |
|                                      |   | 234,713            |   | 227,815                |   |
| Accumulated depreciation and amortization |   | 182,974            |   | 173,033                |   |
| Property, plant and equipment, net        |   | $                  | 51,739 |                   | $      | 54,782 |   |

 

**6.             OTHERACCRUED EXPENSES AND LIABILITIES**

 

Otheraccrued expenses and liabilities consist of the following:

 
|                                   |   | **June 30,  2003** |   | **December 31,  2002** |   |
|----------------------------------------|--------|--------------------|--------|------------------------|--------|
|                                   |   | **(In thousands)** |   |
| Salaries, wages and other compensation |   | $                  | 15,079 |                   | $      | 12,169 |   |
| Accrued taxes, other than income taxes |   | 5,387              |   | 8,794                  |   |
| Advances from customers                |   | 1,770              |   | 586                    |   |
| Accrued interest payable               |   | 3,214              |   | 4,951                  |   |
| Accrued invoices and costs             |   | 2,084              |   | 2,395                  |   |
| Accrued contract completion costs      |   | 3,132              |   | 4,590                  |   |
| Other                                  |   | 12,827             |   | 13,398                 |   |
|                                   |   | $                  | 43,493 |                   | $      | 46,883 |   |

 

**7.             DEBTAND OTHER OBLIGATIONS**

 

Debtand other obligations consist of the following:

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

 

9

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Revolving Credit Facility.  The Company has a revolving credit facility(the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which willmature on May 30, 2006.   Effective May7, 2003, the Company and Heller entered into an amendment to the Revolver whichreduced the committed amount from $60 million to $40 million, while increasingthe letter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.  OnNovember 27, 2002, the Company and Heller entered into an amendment to theRevolver that added pledged cash to the borrowing base.  Funds availability under the Revolver isdetermined by a borrowing-base formula equal to a specified percentage of thevalue of the Company’s eligible accounts receivable, inventory and pledgedcash. At June 30, 2003, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $26.8million.  The balance remaining underthe Revolver that the Company can draw was $13.1 million at June 30, 2003.  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) 1.50% over prime or (2) 3.00% over LIBOR.  The interest-rate margins over prime andLIBOR may be increased by 0.25% increments when borrowing availability fallsbelow (1) $12.5 million or decreased by 0.25% increments when borrowingcapacity exceeds (1) $17.5 million, (2) $22.5 million, and (3) $27.5 million(total rate decrease of 0.75%).  At June30, 2003, the Company’s weighted average rate on the Revolver was 5.00%.

 

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, 2003 of $28.0 million represents lockboxcash receipts to be applied to the outstanding borrowings under the Revolverand cash pledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties andcovenants, including financial covenants as to maximum capital expenditures,minimum fixed-charge coverage ratio and minimum average borrowing availability.At June 30, 2003, the Company was in compliance with all covenants under the Revolver.

 

Senior Notes.  Interest on the Senior Notes is fixed at7.5% and is due and payable in semi-annual installments. Payments beganDecember 1, 1998. The Notes contain covenants placing limitations on theCompany’s ability to permit subsidiaries to incur certain debts, incur certainloans, and engage in certain sale and leaseback transactions. During the first six months of 2003, the Companyrepurchased Senior Notes with a face amount of $3.9 million. The Company wroteoff a proportionate share of deferred financing-fees, resulting in a gain ofapproximately $1.1 million, which was reported as sundry (other) income in thecondensed consolidated statements of operations for the interim periodsended June 30, 2003.  The estimated fair value of the SeniorNotes as of June 30, 2003, is approximately $60.5 million based on an averagevalue of recently completed market trades, resulting in a yield-to-maturity ofapproximately 19%.  The number of actualtrades is limited; therefore the result may vary if a widely-traded marketenvironment existed.

 

Subordinated Unsecured Sponsor Note.The Company’s Sponsor Note bears interest at 10.0%, due and payable quarterly.The Sponsor Note is subordinate only upon bankruptcy or insolvency of theCompany, or if upon maturity of the Senior Notes, the Senior Notes remainunpaid.  The payments began September30, 1999. As provided under the agreement, however, the Sponsor Note holder,WCAS, elected to defer quarterly interest payments of $4.0 million for each ofthe September 2000 through September 2001 quarterly periods resulting in anincrease in the principal amount of the Sponsor Note totaling $33.8million.  Such election required adeferred financing-fee of 30.0% of each of the interest payments beingdeferred.  The Company accounts for theadditional financing fees as a change in the effective interest rate of thedebt. WCAS may, at its election, defer each future quarterly payment undersimilar terms.  WCAS has not elected todefer the quarterly payments since September 2001.  In accordance with the terms of the Sponsor Note, on December 6,2002, the Company made a $90.0 million principal payment on the SponsorNote.  A holder of the Senior Notes iscontesting this payment.  See discussionunder Legal Proceedings.  The estimatedfair-value of the Sponsor Note and deferred interest and fees as of June 30,2003, is approximately $60.2 million assuming a yield-to-maturity of 24%.

 

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

 

Capital Leases.  During the first quarter of 2003, theCompany entered into a capital lease for $2.0 million that pertained tocomputer hardware.  Amounts due undercapital leases are recorded as liabilities. The Company’s interest in assetsacquired under capital leases is recorded as property and equipment on theCondensed Consolidated Balance Sheets. Amortization of assets recorded undercapital leases is included in depreciation expense.  The current obligations under capital leases are classified inthe current liabilities section of the Condensed Consolidated Balance Sheetsand the non-current portion of capital leases are included in OtherLiabilities.

 

**8.             GOODWILL AND INTANGIBLE ASSETS**

 

BeginningJanuary 1, 2002, the Company adopted Statement of Financial Accounting Standard(“SFAS”) No. 142, “Goodwill and 

 

10

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OtherIntangible Assets” (See “New Accounting Pronouncements”).  SFAS No. 142 requires that goodwill andintangible assets with indefinite useful lives no longer be amortized butinstead be tested for impairment at least annually.  SFAS No. 142 also requires that intangible assets with definiteuseful lives be amortized over their respective estimated useful lives to theirestimated residual values.

 

SFAS No. 142 requires atwo-step process for testing impairment. First, the fair-value of eachreporting unit is compared to its carrying value to determine whether anindication of impairment exists. If impairment is indicated, then under thesecond step the fair-value of the reporting unit’s goodwill is determined byallocating the unit’s fair-value to its assets and liabilities (including anyunrecognized intangible assets) as if the reporting unit had been acquired in abusiness combination. The amount of impairment for goodwill is measured as theexcess of its carrying value over its fair-value.  During the first quarter of 2002, the Company recorded as acumulative effect of a change in accounting principle, a non-cash charge of$6.9 million, after applicable income taxes, to write off a portion of thecarrying value of goodwill.

 

Components of theCompany’s goodwill include amounts that are foreign-currency denominated.  These goodwill amounts are subject totranslation at each balance sheet date. The Company records the change to its Accumulated Other ComprehensiveLoss on the balance sheet.  Goodwillpreviously classified as unallocated has been allocated to the reporting unitsas required by SFAS No. 142. The followingis a summary of changes in the carrying amount of goodwill by segment for thesix months ended June 30, 2003:

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

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

 

**9.             WARRANTY LIABILITY**

 

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

 

Changes to the Company’s warranty liability during the sixmonths ended June 30, 2003 are summarized as follows:

 
|                                              |   | **(In  thousands)** |   |
|---------------------------------------------------|--------|---------------------|--------|
| Balance at  December 31, 2002                     |   | $                   | 139    |   |
| Warranties  issued                                |   | 75                  |   |
| Claims  paid/settlements                          |   | (174                | )      |
| Changes in  liability for pre-existing warranties |   | —              |   |
| Balance at June  30, 2003                         |   | $                   | 40     |   |

 

11

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**10.          COMPREHENSIVE INCOME (LOSS)**

 

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

 
|                                      |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|-------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                      |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
|                                      |   | **(In thousands)**              |   | **(In thousands)**            |   |
| Net income  (loss)                        |   | $                               | 303    |                          | $      | 955 |   | $ | (146 | ) | $ | (9,007 | ) |
| Foreign currency  translation adjustments |   | 740                             |   | 2,149                         |   | 637 |   | 2,453 |   |
| Total  comprehensive income (loss)        |   | $                               | 1,043  |                          | $      | 3,104 |   | $ | 491 |   | $ | (6,554 | ) |

 

**11.         ****BUSINESS SEGMENT DATA**

 

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

 
|                                      |   | **US  Solutions**  |   | **Computer  & Network   Services** |   | **International** |   | **Corp/Elims** |   | **Total** |   |
|-------------------------------------------|--------|--------------------|--------|----------------------------------------|--------|-------------------|--------|----------------|--------|-----------|--------|
|                                      |   | **(In thousands)** |   |
| For the three  months ended June 30, 2003 |   |               |   |                                   |   |              |   |           |   |      |   |
|                                      |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers          |   | $                  | 38,591 |                                   | $      | 32,947            |   | $              | 25,505 |      | $      | — |   | $ | 97,043 |   |
| Intersegment  revenues                    |   | 562                |   | —                                 |   | 1,868             |   | (2,430         | )      | —    |   |
| Segment gross  profits                    |   | 8,613              |   | 6,895                                  |   | 9,110             |   | 265            |   | 24,883    |   |
| Segment operating  income (loss)          |   | 2,378              |   | 4,644                                  |   | 2,010             |   | (3,272         | )      | 5,760     |   |
|                                      |   |               |   |                                   |   |              |   |           |   |      |   |
| For the three  months ended June 30, 2002 |   |               |   |                                   |   |              |   |           |   |      |   |
|                                      |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers          |   | $                  | 36,679 |                                   | $      | 35,928            |   | $              | 22,967 |      | $      | — |   | $ | 95,574 |   |
| Intersegment  revenues                    |   | 544                |   | —                                 |   | 2,971             |   | (3,515         | )      | —    |   |
| Segment gross  profits                    |   | 5,087              |   | 8,828                                  |   | 6,206             |   | 759            |   | 20,880    |   |
| Segment operating  income (loss)          |   | (3,367             | )      | 7,188                                  |   | 721               |   | (778           | )      | 3,764     |   |

 
|                                    |   | **US  Solutions**  |   | **Computer  & Network   Services** |   | **International** |   | **Corp/Elims** |   | **Total** |   |
|-----------------------------------------|--------|--------------------|--------|----------------------------------------|--------|-------------------|--------|----------------|--------|-----------|--------|
|                                    |   | **(In thousands)** |   |
| For the six months  ended June 30, 2003 |   |               |   |                                   |   |              |   |           |   |      |   |
|                                    |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers        |   | $                  | 70,614 |                                   | $      | 63,767            |   | $              | 53,414 |      | $      | — |   | $ | 187,795 |   |
| Intersegment  revenues                  |   | 1,106              |   | —                                 |   | 3,070             |   | (4,176         | )      | —    |   |
| Segment gross  profits                  |   | 15,697             |   | 12,862                                 |   | 18,537            |   | 275            |   | 47,371    |   |
| Segment operating  income (loss)        |   | 2,625              |   | 8,477                                  |   | 4,361             |   | (5,656         | )      | 9,807     |   |
| Segment  identifiable assets            |   | 100,006            |   | 28,518                                 |   | 53,644            |   | 61,121         |   | 243,289   |   |
| Capital  appropriations                 |   | 1,349              |   | 587                                    |   | 2,761             |   | 2,463          |   | 7,160     |   |
|                                    |   |               |   |                                   |   |              |   |           |   |      |   |
| For the six months  ended June 30, 2002 |   |               |   |                                   |   |              |   |           |   |      |   |
|                                    |   |               |   |                                   |   |              |   |           |   |      |   |
| Revenue from  external customers        |   | $                  | 75,478 |                                   | $      | 72,167            |   | $              | 45,210 |      | $      | — |   | $ | 192,855 |   |
| Intersegment  revenues                  |   | 1,037              |   | —                                 |   | 7,935             |   | (8,972         | )      | —    |   |
| Segment gross  profits                  |   | 13,499             |   | 16,454                                 |   | 13,566            |   | 331            |   | 43,850    |   |
| Segment operating  income (loss)        |   | (2,828             | )      | 10,976                                 |   | 2,730             |   | (2,863         | )      | 8,015     |   |
| Segment  identifiable assets            |   | 108,883            |   | 33,317                                 |   | 53,334            |   | 41,410         |   | 236,944   |   |
| Capital  appropriations                 |   | 1,989              |   | 588                                    |   | 768               |   | 219            |   | 3,564     |   |

 

12

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**12.          PREFERREDSTOCK**

 

**MANDATORY REDEEMABLE PREFERRED STOCK**

 

The Company allocated the proceeds from itsSeries A preferred stock issuance based upon the relative fair-value of thepreferred stock and warrants issued. The related discount is being accretedsuch that the carrying amount of the mandatory redeemable preferred stock willequal the mandatory redemption amount at September 22, 2008. For the six monthsended June 30, 2003, accretion ofthe related discount and accrued but unpaid dividends totaled $0.8 million,increasing the carrying amount to $15.7 million. As of June 30, 2003, the stated value of the Series A preferredstock, including accumulated but unpaid dividends, was $181.36 per share.  Beginning with the quarter ended March 31,2004, the mandatory redeemable preferred stock issued by the Companywill be reclassified to the liability section of the balance sheet as requiredby SFAS 150 and will initially be measured at fair value.

 

**SERIES BPREFERRED STOCK**

 

For the six months ended June 30, 2003, the Company accrued additional unpaid dividendsfor its Series B preferred stock totaling $1.1 million, increasing the carryingamount to $9.4 million.  As of June30, 2003, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $264.30 pershare.

 

**13.          RECENTACCOUNTING PRONOUNCEMENTS**

 

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

 

In October 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” which replaces SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of.” The Company adopted the provisions of SFAS No. 144, withouteffect, on January 1, 2002.  Under theprovision of SFAS No. 144, the Company has reported the disposition of the saleof its wholly-owned subsidiary, BancTec Japan, as a discontinued operation (SeeNote 2 – Discontinued Operations).

 

InMay 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4,44, and 64, Amendment of SFAS No. 13, and Technical Corrections”.  Among other things, SFAS 145 rescinds variouspronouncements regarding early extinguishment of debt and allows extraordinaryaccounting treatment for early extinguishment only when the provisions ofAccounting Principles Board Opinion No. 30, “Reporting the Results ofOperations—Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transaction”, aremet. The Company adopted the provisions SFAS 145 regarding earlyextinguishment of debt during the second quarter of 2002 and such gains arerecorded in the Statement of Income under Sundry, net.

 

InJuly 2002, the FASB issued SFAS No. 146, “Accounting for Exit or DisposalActivities”.  This statement requirescompanies to recognize costs associated with exit or disposal activities whenthey are incurred rather than at the date of a commitment to an exit ordisposal plan.  SFAS No. 146 nullifiesEITF Issue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurredin a Restructuring),” and will be applied prospectively to exit or disposalactivities initiated after December 31, 2002. The Company adopted SFAS No. 146 on January 1, 2003 with no impact to theCompany’s financial statements.

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an amendment of SFAS No. 123.”  This statement provides alternative methodsof transition for a voluntary change to the fair-value based method of accountingfor stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123and APB Opinion No. 28, “Interim Financial Reporting,” to require prominentdisclosures in both annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results.  The Companyimplemented SFAS No. 148 on January 1, 2003, regarding disclosure requirementsfor condensed financial statements for interim periods.  The Company has not yet determined whetherit will voluntarily change to the fair-value based method of accounting forstock-based employee compensation

 

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

 

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the disclosure requirements are effective for interim and annualfinancial-statement periods ending after December 15, 2002. The Company hasadopted FIN 45 with no impact on the Company’s results of operations orfinancial position.

 

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”). FIN46 requires that unconsolidated variable-interest entities be consolidated bytheir primary beneficiaries. A primary beneficiary is the party that absorbs amajority of the entity’s expected losses or residual benefits. FIN 46 appliesimmediately to variable-interest entities created after January 31, 2003 and toexisting variable-interest entities in the periods beginning after June 15,2003.  Based on preliminary evaluation,Fin 46 is not anticipated to have a material effect on the Company’s results ofoperations or financial position.

 

In November 2002, the FASB’s Emerging Issues Task Force (“EITF”)reached a consensus on Issue 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables,” which must be applied to all revenue arrangementsentered into no later than June 30, 2003. EITF 00-21 governs how toidentify whether goods or services or both that are to be delivered separatelyin a bundled sales arrangement should be accounted for separately. Theappropriate accounting literature for revenue recognition would then be appliedto each unit.  The Company is currentlyevaluating the impact of adoption of EITF 00-21, and does not believe that itwill have a material impact on the financial statements.

 

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

 

**14. SUBSEQUENT EVENTS**

 

None

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND**

**RESULTS OF OPERATIONS.**

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

*This Quarterly Report on Form 10-Q, including FactorsAffecting the Company’s Business and Prospects set forth in Management’sDiscussion and Analysis of Financial Condition and Results of Operations andQuantitative and Qualitative Disclosure About Market Risk, containsforward-looking statements as that term is defined in the Private SecuritiesLitigation 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 and motivatekey employees; the timely development, production and acceptance of productsand services and their feature sets; the challenge of managing asset levels,including inventory; the flow of products into third-party distributionchannels; the difficulty of keeping expense growth at modest levels whileincreasing revenues; and other risks that are described from time to time inthe Company’s Securities and Exchange Commission reports, including but notlimited to the items discussed in “Factors Affecting the Company’s Business andProspects” set forth in this report, and items described in the Company’s otherfilings with the Securities and Exchange Commission. The Company undertakes noobligation to update or revise forward-looking statements to reflect changes inassumptions, the occurrence of unanticipated results or changes to futureoperating results over time.*

 

The Company believes several factors continued to create a challengingand competitive sales and cost containment environment during the six monthsended June 30, 2003.  These factorsinclude: general economic conditions and reduced corporate customer technologyspending, ongoing competitive pressures, and a highly leveraged financialposition.

 

Expected economic and business conditions for the remainder of 2003indicate 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.  The Company has concentratedits emphasis on cost reductions and on existing offerings. Product-developmentefforts are 

 

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currently focused on payment, check and document processingtechnologies, in addition to investments in Electronic Document Management(“EDM”) vertical solutions and an investment in archiving solutions for allmarkets, as well as hardware enhancements. By incorporating more third-partyproducts into the Company’s solutions rather than developing the products, theCompany can more easily target its efforts and expenditures to these coreproducts and solutions.

 

**RESULTS OF OPERATIONS**

 

**Comparison of Three Months Ended June 30, 2003 and ThreeMonths Ended June 30, 2002**

 

Consolidated revenue of $97.0 million for the threemonths ended June 30, 2003 increased by $1.4 million or 1.5% from thecomparable prior-year period. Increases in USS of $1.9 million resultedprimarily from strengthening demand for the Company’s system integrationservices, partially offset by declines in maintenance revenue due to Companyinstalled products reaching the end of their useful lives and from increasedcompetition.  Increases in INTL of $2.5million are the result of increases in some areas of Europe and the UK inmaintenance revenue as well as the introduction in the UK of documentprocessing services.  These increaseswere somewhat offset by continued economic weakness in some areas ofEurope.  In addition, the impact of theweakening dollar on the conversion of revenue stated in foreign currenciesaccounted for some of the increase.  Adecrease in CNS of $3.0 million resulted from pricing decreases resulting fromcompetitive pressure, as well as decreased volume under certain maintenanceprograms.  The Company expects thesetrends to continue in the foreseeable future. Factors impacting future revenueinclude corporate-customer spending for large systems-solutions, customer andprospective customer mergers, on-going competitive pressures, and fluctuationsin international currencies.

 

Consolidated gross profit of $24.9 millionincreased by $4.0 million or 19.1% from the comparable prior-year period.Increases in USS of $3.5 million and in INTL of $2.9 million were partiallyoffset by a decrease in CNS of $1.9 million. A portion of the gross profit increase in USS and INTL resulted fromincreased revenues while a portion resulted from an increase in the grossprofit percentage.  The USS percentageincreased from 13.9% to 22.3% while the INTL percentage increased from 27.0% to35.7% mainly resulting from the Company’s cost-containment efforts.  CNS’ gross profit decrease resultedprimarily from decreased revenues as well as margin pressure caused byincreased competition.  The Company isin the process of transitioning its product offering focus to provendeliverables and new targeted offerings, including EDM solutions, its otherarchive solutions and hardware enhancements. Incorporating more third-party products into the Company’s solutionsrather than developing the products has enabled the concentration of effortsand expenditures on the targeted items which, along with the Company’s ongoingcost-containment efforts, allowed for cost reductions to strengthen theCompany’s margins.

 

Operating expenses of $19.1 million increased$2.0 million compared to the prior-year period. Operating expenses, bycomponent, changed as follows: Product-development expenses decreased by $0.2million or 5.1% primarily due to the use of outsourced product-developmentservices. Selling, general, and administrative expenses increased by $2.2million or 16.7% due to increased SG&A depreciation expense and theimpact of the weakening dollar on the conversion of expenses stated in foreigncurrencies.

 

Interest expense for the three monthsended June 30, 2003  decreased to $4.8 million from $7.6 million inthe comparable prior-year period. The decrease was due mainly to thepayment of $90.0 million on the Sponsor Note in December 2002, the repurchaseof a portion of the Senior Notes, anddeclining interest rates.

 

Sundry items resulted in a net income of $0.2 million during the threemonths ended June 30, 2003 ascompared to a net income of $4.5 million during the comparable prior-year period. This decrease is primarily due to a gain of approximately $0.1 millionfrom the Company’s repurchase of Senior Notes and foreign-exchange gains of$0.1 million during the current-year period, compared to a gain from therepurchase of Senior Notes of $2.8 million and foreign-exchange gains of $1.6million in the prior-year period.

 

Pre-tax income in foreign tax jurisdictions resulted in an income taxprovision of $1.2 million for the three months ended June 30, 2003 compared to a corresponding prior-year period incometax provision of $0.6 million.  Theincome tax provisions for both periods related primarily to income from theCompany’s international subsidiaries. The Company’s effective tax rate was approximately 79.3% for the threemonths ended June 30, 2003 ascompared to 88.2% for the corresponding prior-year period.

 

**Comparison of Six Months Ended June 30, 2003 and Six MonthsEnded June 30, 2002**

 

Consolidated revenue of $187.8 million for thesix months ended June 30, 2003 decreased by $5.1 million or 2.6% from thecomparable prior-year period. Decreases in USS of $4.9 million resultedprimarily from the overall weakness in hardware sales during the first quarterof 2003.  In addition, USS experienceddeclines in maintenance revenue due to Company installed products reaching theend of their useful lives and from increased competition.  Increases in INTL of $8.2 million are aresult of strengthening demand in Europe and the UK for the Company’s softwareproducts, increases in maintenance revenue, and the introduction in the UK ofdocument processing services during 2003. A decrease in CNS of $8.4 million resulted from pricing decreasesresulting from competitive pressure, as well as decreased volume under certainmaintenance programs.  Factors that mostimpact future revenue include corporate-customer spending for largesystems-solutions, customer and prospective customer mergers, on-goingcompetitive pressures, and fluctuations in international currencies.

 

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Consolidated gross profit of $47.4 millionincreased by $3.5 million or 8.0% from the comparable prior-year period.Increases in USS of $2.2 million and in INTL of $5.0 million were partiallyoffset by decreases in CNS of $3.6 million. Although decreased revenues impacted USS gross profit, the gross profitpercentage increased from 17.9% to 22.2% resulting from the Company’scost-containment efforts. CNS’ gross profit decrease resulted primarilyfrom decreased revenues as well as margin pressure caused by increasedcompetition.  The INTL increase resulted primarily from increased revenues and anincrease in gross profit percentage resulting from cost-containmentefforts.  The Company is in theprocess of transitioning its product offering focus to proven deliverables andnew targeted offerings, including EDM solutions, its other archive solutionsand hardware enhancements. Incorporating more third-party products into the Company’s solutionsrather than developing the products has enabled the concentration of effortsand expenditures on the targeted items which, along with the Company’s ongoingcost-containment efforts, allowed for cost reductions to help offset revenuedeclines.

 

Operating expenses of $37.6 million increased$1.8 million compared to the prior-year period. Operating expenses, bycomponent, changed as follows: Product-development expenses increased by$0.2million or 2.8% primarily due to concentration on developing targeted newapplications for the Company’s product lines and the selective expansion ofexisting products. Selling, general, and administrative expenses decreased by$1.5 million or 5.2% due to the Company’s ongoing cost-containmentefforts.

 

Interest expense for the six months ended June 30, 2003  decreased to $9.7 million from $15.2 million in the comparable prior-yearperiod. The decrease was due mainly to the payment of $90.0 million onthe Sponsor Note in December 2002, the repurchase of a portion of the SeniorNotes, and declining interest rates.

 

Sundry items resulted in a net income of $1.4 million during the sixmonths ended June 30, 2003 ascompared to a net income of $4.0 million during the comparable prior-year period. This decrease is primarily due to a gain of approximately $1.1 millionfrom the Company’s repurchase of Senior Notes and foreign-exchange gains of$0.3 million during the current-year period, compared to a gain on therepurchase of Senior Notes of $2.8 million and foreign-exchange gains of $1.1million in the prior-year period.

 

Pre-tax income in foreign tax jurisdictions resulted in an income taxprovision of $1.8 million for the six months ended June 30, 2003 compared to a corresponding prior-year period incometax provision of $0.8 million.  Theincome tax provisions for both periods related primarily to income from theCompany’s international subsidiaries. The Company’s effective tax rate was approximately 91.9% for the sixmonths ended June 30, 2003 ascompared to (24.7)% for the corresponding prior-year period.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The Company’s working capital requirements are generally provided bycash and cash equivalents, funds available under the Company’s revolving creditagreement, as discussed below, which matures May 30, 2006, and by internallygenerated funds from cash flows from operations. Funds availability under therevolving credit agreement is determined by a borrowing-base formula equal to aspecified percentage of the value of the Company’s eligible accountsreceivable, inventory and pledged cash. General economic conditions, the current weakness in demand for theCompany’s systems solutions products offered by USS and the requirement toobtain performance bonds or similar instruments could have an impact on theCompany’s future liquidity.

 

The Company’s cash and cash equivalents totaled$53.0 million at June 30, 2003,compared with $31.6 million at December 31, 2002. Working capital increased$4.8 million during the six months ended June 30, 2003 to a working-capital deficit of $4.1 millioncompared to a working-capital deficit of $8.9 million at December 31,2002.  The change in working capital includeda current liability increase of $13.4 million from increased deferred revenueand accrued expenses, an accountsreceivable decrease of $9.5 million and an inventory increase of $3.7 million.

 

During the six months ended June 30, 2003, the Company relied primarily on cash flowsgenerated from operating activities and short-term borrowings under its revolvingcredit agreement to fund operations. At June30, 2003, the Company had available $39.9million of borrowing capacity under the Revolver, of which the Companycan draw $13.1 million.

 

Operating activities provided $27.8 million and$22.9 million of cash in the six months ended June 30, 2003 and 2002, respectively, an increase of  $4.9 million.  Although net income from continuing operations increased $11.1million, $6.8 million of this improvement resulted from lower depreciation andamortization and other non-cash transactions. In addition, cash generated by changes in working capital assets andliabilities was $3.8 million more than in the prior-year period.

 

Investing activities used net cash of $3.3million and $4.0 million in the six months ended June 30, 2003 and 2002, respectively. Both uses of cashrelated to purchases of property, plant and equipment.

 

Financing activities used $3.4 million and $22.7million of net cash in the six months ended June 30, 2003 and 2002, respectively. The $19.3 million changerelated primarily to the reduction of the Company’s debt.

 

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At June 30, 2003, the Company’s principal outstanding debt instrumentsconsisted of (i) no balance outstanding under the revolving credit facilitymaturing May 30, 2006 (which is more fully described below), (ii)  $94.5 million of 7.5% Senior Notes due 2008,and (iii) $103.8 million of Sponsor Notes due 2009. The Company or itsaffiliates may from time to time purchase, redeem or pay deferred interest onsome of its outstanding debt or equity securities.  The Company would only make these payments in compliance with thecovenants of its debt instruments.

 

The Company continually 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 fromtime to 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 agreementsor agreements in principle to sell any assets and there can be no assurancethat any such asset sales will occur or, if they occur, as to the timing oramount of proceeds that such asset sales may generate.

 

**RevolvingCredit Facility.**The Company has a revolving credit facility(the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which willmature on May 30, 2006.  Effective May7, 2003, the Company and Heller entered into an amendment to the Revolver whichreduced the committed amount from $60 million to $40 million, while increasingthe letter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially allthe assets of the Company, subject to the limitations on liens contained in theCompany’s existing Senior Notes.  OnNovember 27, 2002, the Company and Heller entered into an amendment to theRevolver that added pledged cash to the borrowing base.  Funds availability under the Revolver isdetermined by a borrowing-base formula equal to a specified percentage of thevalue of the Company’s eligible accounts receivable, inventory and pledgedcash. At June 30, 2003, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $26.8million.  The balance remaining under theRevolver that the Company can draw was $13.1 million at June 30, 2003.  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) 1.50% over prime or (2) 3.00% over LIBOR.  The interest-rate margins over prime andLIBOR may be increased by 0.25% increments when borrowing availability fallsbelow (1) $12.5 million or decreased by 0.25% increments when borrowingcapacity exceeds (1) $17.5 million, (2) $22.5 million, and (3) $27.5 million(total rate decrease of 0.75%).  At June30, 2003, the Company’s weighted average rate on the Revolver was 5.00%.

 

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, 2003 of $28.0 million represents lockboxcash receipts to be applied to the outstanding borrowings under the Revolverand cash pledged under the terms of the Revolver.  The Revolver contains various representations, warranties andcovenants, including financial covenants as to maximum capital expenditures,minimum fixed-charge coverage ratio and minimum average borrowingavailability.  At June 30, 2003, theCompany was in compliance with all covenants under the Revolver.  On July30, 2002, the Company and Heller amended the Revolver, which reduced theCompany’s fixed-charge coverage ratio covenant during quarters 1, 2 and 3 of2002, and reduced the minimum undrawn availability requirement from $10.0million to $4.0 million

 

**Senior Notes**. In August 1998, the Company exchanged the public Senior Notes (the“Senior Notes”) for the notes sold in a May 1998 Rule 144A private offering.Interest is fixed at 7.5% and is due and payable in semi-annual installments,which began December 1, 1998. The Senior Notes contain covenants placinglimitations on the Company’s ability to permit subsidiaries to incur certaindebts, incur certain loans, and engage in certain sale and leasebacktransactions. During the six months ended June 30, 2003, the Companyrepurchased Senior Notes with a face amount of $3.9 million. The Company wroteoff a proportionate share of deferred financing-fees, resulting in a gain ofapproximately $1.1 million, which was reported as sundry (other) income in thecondensed consolidated statements of operations for the six months ended June 30, 2003.

 

**SubordinatedUnsecured Sponsor Note**. The Company’s Sponsor Note bearsinterest at 10.0%, due and payable quarterly. The Sponsor Note is subordinateonly upon bankruptcy or insolvency of the Company, or if upon maturity of theSenior Notes, the Senior Notes remain unpaid. The payments began September 30, 1999. As provided under the agreement,however, the Sponsor Note holder, 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 September2001.  In accordance with the terms ofthe Sponsor Note, on December 6, 2002, the Company made a $90.0 millionprincipal payment on the Sponsor Note. A holder of the Senior Note is contesting this payment.  See discussion under Legal Proceedings.

 

**Preferred Stock – Series A**.****The Company allocated the proceeds fromits Series A preferred stock issuance based upon the relative fair-value of thepreferred stock and warrants issued. The related discount is being accretedsuch that the carrying amount of the mandatory redeemable preferred stock willequal the mandatory redemption amount at September 22, 2008. For the six monthsended 

 

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June 30, 2003, accretion of therelated discount and accrued but unpaid dividends totaled $0.8 million,increasing the carrying amount to $15.7 million. As of June 30, 2003, the stated value of the Series A preferredstock, including accumulated but unpaid dividends, was $181.36 per share.

 

**Preferred Stock – Series B**.****For the six months ended June 30,2003, the Company accrued additional unpaiddividends for its Series B preferred stock totaling $1.1 million, increasingthe carrying amount to $9.4 million.  Asof June 30, 2003, the stated valueof the Series B preferred stock, including accumulated but unpaid dividends,was $264.30 per share.

 

Inflation has not had a material effect on theoperating results of the Company.

 

### **Contractual Obligations 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 June30, 2003:

 
|                              |   | **Total  Amounts** |   | **Less than  1 Year** |   | **1-3  Years** |   | **4-5  Years** |   | **Over 5  Years** |   |
|-----------------------------------|--------|--------------------|--------|-----------------------|--------|----------------|--------|----------------|--------|-------------------|--------|
| **(In Millions)**                 |   |
| Long-term debt                    |   | $                  | 197.8  |                  | $      | —         |   | $              | — |              | $      | 94.0 |   | $ | 103.8 |   |
| Capital leases                    |   | 1.8                |   | 1.0                   |   | 0.8            |   | —         |   | —            |   |
| Operating leases (non-cancelable) |   | 19.5               |   | 6.4                   |   | 6.9            |   | 5.0            |   | 1.2               |   |
| Total Contractual                 |   | 219.1              |   | 7.4                   |   | 7.7            |   | 99.0           |   | 105.0             |   |
|                              |   |               |   |                  |   |           |   |           |   |              |   |
| Unused lines of credit            |   | $                  | 13.1   |                  | $      | 13.1           |   | $              | — |              | $      | — |   | $ | — |   |
| Standby letters of credit         |   | 26.8               |   | 26.8                  |   | —         |   | —         |   | —            |   |
| Total Commercial                  |   | $                  | 39.9   |                  | $      | 39.9           |   | $              | — |              | $      | — |   | $ | — |   |

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

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

 

In October 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” which replaces SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of.” The Company adopted the provisions of SFAS No. 144, withouteffect, on January 1, 2002.  Under theprovision of SFAS No. 144, the Company has reported the disposition of the saleof its wholly-owned subsidiary, BancTec Japan, as a discontinued operation (SeeNote 2 – Discontinued Operations).

 

InMay 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4,44, and 64, Amendment of SFAS No. 13, and Technical Corrections”.  Among other things, SFAS 145 rescindsvarious pronouncements regarding early extinguishment of debt and allowsextraordinary accounting treatment for early extinguishment only when the provisionsof Accounting Principles Board Opinion No. 30, “Reporting the Results ofOperations—Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transaction”, aremet. The Company adopted the provisions SFAS 145 regarding earlyextinguishment of debt during the second quarter of 2002 and such gains arerecorded in the Statement of Income under Sundry, net.

 

InJuly 2002, the FASB issued SFAS No. 146, “Accounting for Exit or DisposalActivities”.  This statement requirescompanies to recognize costs associated with exit or disposal activities whenthey are incurred rather than at the date of a commitment to an exit ordisposal plan.  SFAS No. 146 nullifiesEITF Issue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurredin a Restructuring),” and will be applied prospectively to exit or disposalactivities initiated after December 31, 2002. The Company adopted SFAS No. 146 on January 1, 2003 with no impact tothe Company’s financial statements.

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an 

 

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

 

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

 

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”). FIN46 requires that unconsolidated variable-interest entities be consolidated bytheir primary beneficiaries. A primary beneficiary is the party that absorbs amajority of the entity’s expected losses or residual benefits. FIN 46 appliesimmediately to variable-interest entities created after January 31, 2003 and toexisting variable-interest entities in the periods beginning after June 15, 2003.  Based on preliminary evaluation, Fin 46 isnot anticipated to have a material effect on the Company’s results ofoperations or financial position.

 

In November 2002, the FASB’s Emerging Issues Task Force (“EITF”)reached a consensus on Issue 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables,” which must be applied to all revenue arrangementsentered into no later than June 30, 2003. EITF 00-21 governs how toidentify whether goods or services or both that are to be delivered separatelyin a bundled sales arrangement should be accounted for separately. Theappropriate accounting literature for revenue recognition would then be appliedto each unit.  The Company is currentlyevaluating the impact of adoption of EITF 00-21, and does not believe that itwill have a material impact on the financial statements.

 

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

 

**FACTORSAFFECTING THE COMPANY’S BUSINESS AND PROSPECTS**

 

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

 

***General 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, hightechnology and governmental agencies. General economic conditions that cause customers in such industries toreduce or delay their investments in products and solutions such as thoseoffered by the Company could have a material adverse effect on the Company.

 

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

 

***Dependence on Suppliers***

 

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

 

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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.

 

***Declining Financial Operating Results andIndebtedness***

 

As a result of increased leverage and reduced performance over the lastfew years, certain negative consequences of the Company’s indebtedness couldoccur, such as restrictions on expenditures or other activities.  The Company’s future operating flexibilitymay be impacted.  In addition, theCompany may be more vulnerable to an increase in interest rates, a downturn inits operating performance or a decline in general economic conditions.

 

***International Activities***

 

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

 

***Fluctuations in Operating Results***

 

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

 

***Technological Changes and ProductTransitions***

 

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

 

***Product Development Activities***

 

The strength of the Company’s overall business is partially dependenton the Company’s ability to develop products and solutions based on new orevolving technology and the market’s acceptance of those products.  There can be no assurance that the Company’sproduct-development activities will be successful, that new technologies willbe available to the Company, that the Company will be able to deliver commercialquantities of new products in a timely manner, that those products will adhereto generally accepted industry standards or that products will achieve marketacceptance. The Company believes that it is necessary for its products toadhere to generally accepted industry standards, which are subject to change inways that are beyond the control of the Company.

 

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKETRISK.**

 

The Company utilizes a revolving credit facilityto support working capital needs. The interest rate on loans under theRevolver is, at the Company’s option, either (i) 1.50% over prime or (ii) 3.00%over LIBOR. Although no actual balanceswere outstanding under the Revolver at June 30, 2003, assuming $1.0 million inborrowings under the Revolver, a one hundred basis point change in the bank’sprime or LIBOR rate would impact net interest expense by $10,000 over atwelve-month period.

 

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**ITEM 4. CONTROLS AND PROCEDURES.**

 

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

 

The Company has addressed the individual internal control weaknessesnoted by D&T and KPMG.  Steps thathave been implemented to address internal control weaknesses include policiescovering loss contracts, inventory reserves, allowance for doubtful accounts,revenue recognition, and project costing. In addition, as a result of Exchange Act Rule 13a-14, the Company hasbegun to put in place procedures addressing the adequacy of disclosurecontrols, including obtaining certifications from each member of managementinvolved in the preparation and review of this Form 10-Q.  The Company is continuing its efforts toevaluate and correct internal control weaknesses noted by D&T and KPMG, aswell as document the system of internal controls.  Although the Company believes that it has implemented adequatecontrols and procedures for the preparation of this report, the adequacy of theactions taken by the Company to correct certain of the previously identifiedweaknesses will not be fully known until the completion of documentation of theCompany’s system of internal controls.

 

The Chief Executive Officer and the Chief FinancialOfficer of the Company, with the participation of the Company’s management,continue to carry out an evaluation of the effectiveness of the Company’sdisclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e).  Based upon the evaluation completed to date,the Chief Executive Officer and the Chief Financial Officer believe that, as ofthe end of the period covered by this report, the Company’s disclosure controlsand procedures are effective in making known to them material informationrelating to the Company (including its consolidated subsidiaries) required tobe included in this report.

 

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

 

There was no change in the Company’s internal controlover financial reporting, known to the Chief Executive Officer or the ChiefFinancial Officer, that occurred during the period covered by this report thathas materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**BANCTEC, INC.**

**PART II**

**OTHER INFORMATION**

 

**ITEM 1. Legal Proceedings**

 

A lawsuit captioned Cerberus International, Ltd., et al. vs.BancTec, Inc., et al. (Case No. 03600287) was filed on January 28, 2003 inthe Supreme Court of the State of New York for the County of New York naming asdefendants the Company and certain of its affiliates.  The complaintalleges that the Company improperly made a payment to the holder of the SponsorNote.  The complaint seeks damages of not less than $89 million as aresult of the alleged improper payment and the imposition of a constructivetrust on monies paid by the Company to the holder of the Sponsor Note. The Company’s $90 million payment to the holder of the Sponsor Note was disclosedin the Company’s Current Report on Form 8-K dated November 27, 2002.  TheCompany and the plaintiff have each submitted a motion for summary judgment, onwhich the court has not yet ruled.  TheCompany believes that the allegations of the complaint are without merit andintends to defend against them vigorously.

 

If the lawsuit were to result in a determination that the payment toreduce the principal amount of the Sponsor Note was in contravention of theterms of the Sponsor Note, a position strongly opposed bythe Company, underits terms, such payment shall be held in trust to be paid over to the holdersof the Senior Notes, to the extent they remain unpaid.  Therefore, in theevent of an unfavorable outcome in this litigation, there will be no adverseeffect on the Company’s financial statements.

 

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

 

**ITEM2.  Changes in Securities and Use ofProceeds**

 

None

 

**ITEM3.  Defaults Upon Senior Securities**

 

None

 

**ITEM 4.  Submission of Matters to a Vote of Security Holders**

 

None

 

**ITEM5. Other Information**

 

None

 

**ITEM 6. Exhibits and Reports on Form8-K**

 

 

(a)          Exhibits:

 

31.1– Certificate of Chief Executive Officer pursuant to Rule 15d-14(a) under theSecurities Exchange Act

 

31.2– Certificate of Chief Financial Officer pursuant to Rule 15d-14(a) under theSecurities Exchange Act

 

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

 

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

 

 

(b)         Reports on Form 8-K:

 

None

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| **BancTec, Inc.**       |
|-------------------------|
|                    |
|                    |
|                    | *By* | */s/* | *Brian R. Stone* |   |
|                    | *Brian R. Stone* |
|                    | *Senior  Vice President on behalf of  the registrant and as Chief  Financial Officer* |
|                    |
| Dated:  August 14, 2003 |

 

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