**UNITED STATESSECURITIES 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  March 31, 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 90 days.       Yes  ý  No  o

 

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

 

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

 

| **Title of  Each Class**              |   | **Number of  Shares Outstanding at  May 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**

**FINANCIALINFORMATION**

** **

**ITEM 1. Financial Statements**

 

**BANCTEC, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

 
|                                                                                                                               |   | **March 31,  2003** |    | **December 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|------------------------|--------|
|                                                                                                                               |   | **(Unaudited)**     |    |                   |   |
| CURRENT ASSETS:                                                                                                                    |   |                |    |                   |   |
| Cash and cash equivalents, including restricted cash  of $15,775 and $88 at March 31, 2003 and December 31, 2002                   |   | $                   | 43,971  |                   | $      | 31,595 |   |
| Accounts receivable, less allowance for doubtful  accounts of  $2,115 and $2,216 at  March 31, 2003 and December 31, 2002          |   | 54,547              |    | 60,891                 |   |
| Inventories, net                                                                                                                   |   | 30,588              |    | 25,528                 |   |
| Prepaid expenses                                                                                                                   |   | 6,084               |    | 5,177                  |   |
| Other current assets                                                                                                               |   | 156                 |    | 334                    |   |
| Total current assets                                                                                                               |   | 135,346             |    | 123,525                |   |
|                                                                                                                               |   |                |    |                   |   |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                                                 |   | 53,148              |    | 54,782                 |   |
|                                                                                                                               |   |                |    |                   |   |
| OTHER ASSETS:                                                                                                                      |   |                |    |                   |   |
| Goodwill                                                                                                                           |   | 41,476              |    | 41,476                 |   |
| Other assets                                                                                                                       |   | 11,391              |    | 11,612                 |   |
| Total other assets                                                                                                                 |   | 52,867              |    | 53,088                 |   |
| TOTAL ASSETS                                                                                                                       |   | $                   | 241,361 |                   | $      | 231,395 |   |
|                                                                                                                               |   |                |    |                   |   |   |   |
| CURRENT  LIABILITIES:                                                                                                              |   |                |    |                   |   |
| Current obligations  under capital leases                                                                                          |   | $                   | 1,047   |                   | $      | — |   |
| Trade accounts  payable                                                                                                            |   | 14,905              |    | 12,891                 |   |
| Other accrued  expenses and liabilities                                                                                            |   | 40,633              |    | 46,883                 |   |
| Deferred revenue                                                                                                                   |   | 31,049              |    | 24,107                 |   |
| Maintenance  contract deposits                                                                                                     |   | 52,978              |    | 47,685                 |   |
| Income taxes                                                                                                                       |   | 1,889               |    | 836                    |   |
| Total current  liabilities                                                                                                         |   | 142,501             |    | 132,402                |   |
|                                                                                                                               |   |                |    |                   |   |
| OTHER LIABILITIES:                                                                                                                 |   |                |    |                   |   |
| Long-term debt,  less current maturities                                                                                           |   | 198,323             |    | 201,723                |   |
| Non-current  maintenance contract deposits                                                                                         |   | 28,380              |    | 25,933                 |   |
| Other liabilities                                                                                                                  |   | 10,950              |    | 9,881                  |   |
| Total other  liabilities                                                                                                           |   | 237,653             |    | 237,537                |   |
|                                                                                                                               |   |                |    |                   |   |
| COMMITMENTS AND  CONTINGENCIES                                                                                                     |   |                |    |                   |   |
|                                                                                                                               |   |                |    |                   |   |
| MANDATORY  REDEEMABLE PREFERRED STOCK-Series A                                                                                     |   | 15,270              |    | 14,856                 |   |
|                                                                                                                               |   |                |    |                   |   |
| STOCKHOLDERS’  DEFICIT:                                                                                                       |   |                |    |                   |   |
| Cumulative  convertible preferred stock - authorized, 1,000,000 shares of $0.01 par value  at March 31, 2003 and December 31, 2002 |   |                |    |                   |   |
| Series B preferred  stock - issued and outstanding,35,520 shares at March 31, 2003 and  December 31, 2002                          |   | 8,837               |    | 8,324                  |   |
| Common stock  authorized, 32,000,000 shares of $0.01 par valueMarch 31,  2003 and December 31, 2002:                               |   |                |    |                   |   |
| Common stock-issued  and outstanding17,003,838 shares at March 31, 2003 and December 31,  2002                                     |   | 170                 |    | 170                    |   |
| Class A common  stock-issued and outstanding 1,181,946 sharesat March 31,  2003 and December 31, 2002                              |   | 12                  |    | 12                     |   |
| Subscription stock  warrants                                                                                                       |   | 3,726               |    | 3,726                  |   |
| Additional paid-in  capital                                                                                                        |   | 130,108             |    | 131,035                |   |
| Accumulated deficit                                                                                                                |   | (286,992            | )       | (286,846               | )      |
| Accumulated other  comprehensive loss                                                                                              |   | (9,924              | )       | (9,821                 | )      |
| Total stockholders’  deficit                                                                                                  |   | (154,063            | )       | (153,400               | )      |
|                                                                                                                               |   |                |    |                   |   |
| TOTAL LIABILITIES  AND STOCKHOLDERS’ DEFICIT                                                                                  |   | $                   | 241,361 |                   | $      | 231,395 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

2

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**BANCTEC, INC.**

# **CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
|                                                                            |   | **Three Months Ended March 31,** |   |
|---------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                            |   | **2003**                         |   | **2002** |   |
|                                                                            |   | **(In thousands)**               |   |
| REVENUE                                                                         |   |                             |   |   |   |
| Equipment and  software                                                         |   | $                                | 34,759 |   | $ | 35,319 |   |
| Maintenance and  other services                                                 |   | 55,993                           |   | 61,962 |   |
|                                                                            |   | 90,752                           |   | 97,281 |   |
| COST OF SALES                                                                   |   |                             |   |   |   |
| Equipment and  software                                                         |   | 23,314                           |   | 26,941 |   |
| Maintenance and  other services                                                 |   | 44,950                           |   | 47,370 |   |
|                                                                            |   | 68,264                           |   | 74,311 |   |
| Gross profit                                                                    |   | 22,488                           |   | 22,970 |   |
|                                                                            |   |                             |   |   |   |
| OPERATING EXPENSES                                                              |   |                             |   |   |   |
| Product development                                                             |   | 3,717                            |   | 3,303 |   |
| Selling, general  and administrative                                            |   | 14,724                           |   | 15,416 |   |
|                                                                            |   | 18,441                           |   | 18,719 |   |
| Income from  operations                                                         |   | 4,047                            |   | 4,251 |   |
|                                                                            |   |                             |   |   |   |
| OTHER INCOME  (EXPENSE):                                                        |   |                             |   |   |   |
| Interest income                                                                 |   | 57                               |   | 32 |   |
| Interest expense                                                                |   | (4,822                           | )      | (7,592 | ) |
| Sundry, net                                                                     |   | 1,203                            |   | (450 | ) |
|                                                                            |   | (3,562                           | )      | (8,010 | ) |
| INCOME (LOSS) FROM  CONTINUING OPERATIONS BEFORE INCOME TAXES                   |   | 485                              |   | (3,759 | ) |
| INCOME TAX EXPENSE                                                              |   | 631                              |   | 214 |   |
| INCOME (LOSS) FROM  CONTINUING OPERATIONS                                       |   | (146                             | )      | (3,973 | ) |
| INCOME FROM  DISCONTINUED OPERATIONS,NET OF TAX EXPENSE $813 at MARCH 31,  2002 |   | —                           |   | 971 |   |
| INCOME (LOSS)  BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE                    |   | (146                             | )      | (3,002 | ) |
| CUMULATIVE EFFECT  OF ACCOUNTING CHANGE                                         |   | —                           |   | (6,960 | ) |
| NET INCOME (LOSS)                                                               |   | (146                             | )      | (9,962 | ) |
| PREFERRED STOCK  DIVIDENDS AND ACCRETION OF DISCOUNT                            |   | (927                             | )      | (790 | ) |
| NET LOSS APPLICABLE  TO COMMON STOCK                                            |   | $                                | (1,073 | ) | $ | (10,752 | ) |

 

See notes to unaudited condensed consolidated financial statements.

 

3

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**BANCTEC, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                            |   | **Three Months Ended March 31,** |   |
|---------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                            |   | **2003**                         |   | **2002** |   |
|                                                                            |   | **(In thousands)**               |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                            |   |                             |   |   |   |
| Net income (loss)                                                               |   | $                                | (146   | ) | $ | (9,962 | ) |
| Income from discontinued operations                                             |   | —                           |   | 971 |   |
| Loss from continuing operations                                                 |   | (146                             | )      | (10,933 | ) |
| Adjustments to reconcile to cash flows provided by  operations:                 |   |                             |   |   |   |
| Cumulative effect of accounting change                                          |   | —                           |   | 6,960 |   |
| Depreciation and amortization                                                   |   | 5,286                            |   | 6,368 |   |
| Provision for doubtful accounts                                                 |   | 94                               |   | 820 |   |
| Loss on disposition of property, plant and equipment                            |   | 233                              |   | 190 |   |
| Gain on extinguishment of long-term debt                                        |   | (996                             | )      | — |   |
| Other non-cash items                                                            |   | 73                               |   | 49 |   |
| Changes in operating assets and liabilities                                     |   |                             |   |   |   |
| Decrease in accounts receivable                                                 |   | 6,250                            |   | 7,264 |   |
| (Increase) decrease in inventories                                              |   | (5,085                           | )      | 286 |   |
| Increase in other assets                                                        |   | (444                             | )      | (66 | ) |
| Increase (decrease) in trade accounts payable                                   |   | 2,014                            |   | (1,780 | ) |
| Increase (decrease) in deferred revenue &  maintenance contracts deposits   |   | 12,235                           |   | (3,563 | ) |
| Increase (decrease) in other accrued expenses and  liabilities                  |   | (2,728                           | )      | 1,763 |   |
| Cash flows provided by continuing operations                                    |   | 16,786                           |   | 7,358 |   |
| Cash flows provided by discontinued operations                                  |   | —                           |   | 719 |   |
| Cash flows provided by operating activities                                     |   | 16,786                           |   | 8,077 |   |
|                                                                            |   |                             |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                            |   |                             |   |   |   |
| Purchases of property, plant and equipment                                      |   | (1,427                           | )      | (2,059 | ) |
| Cash flows used in continuing operations                                        |   | (1,427                           | )      | (2,059 | ) |
| Cash flows provided by discontinued operations                                  |   | —                           |   | 186 |   |
| Cash flows used in investing activities                                         |   | (1,427                           | )      | (1,873 | ) |
|                                                                            |   |                             |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                            |   |                             |   |   |   |
| Payments of current maturities of long-term debt and  capital lease obligations |   | (346                             | )      | — |   |
| Payments on long-term borrowing                                                 |   | (2,387                           | )      | — |   |
| Payments on short-term borrowings, net                                          |   | —                           |   | (21,655 | ) |
| Debt issuance costs                                                             |   | (81                              | )      | (70 | ) |
| Cash flows used in continuing operations                                        |   | (2,814                           | )      | (21,725 | ) |
| Cash flows used in discontinued operations                                      |   | —                           |   | (1,162 | ) |
| Cash flows used in financing activities                                         |   | (2,814                           | )      | (22,887 | ) |
|                                                                            |   |                             |   |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                         |   | (169                             | )      | 432 |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                       |   | 12,376                           |   | (16,251 | ) |
| CASH AND CASH EQUIVALENTS—BEGINNING OF YEAR                                |   | 31,595                           |   | 22,384 |   |
|                                                                            |   |                             |   |   |   |
| CASH AND CASH EQUIVALENTS—END OF YEAR                                      |   | $                                | 43,971 |   | $ | 6,133 |   |
|                                                                            |   |                             |   |   |   |
| SUPPLEMENTAL DISCLOSURES INFORMATION:                                           |   |                             |   |   |   |
| Cash paid (refunded) during the period for:                                     |   |                             |   |   |   |
| Interest                                                                        |   | $                                | 4,519  |   | $ | 5,115 |   |
| Taxes                                                                           |   | $                                | (494   | ) | $ | 1,841 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

4

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**BANCTEC, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.**                                      **NATURE OF 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 at March 31, 2003, and the unaudited condensed consolidated statements of operations and cash flows forthe interim periods ended March 31, 2003 and 2002, should be read inconjunction with BancTec, Inc. and subsidiaries (“BancTec” or the “Company”)consolidated financial statements and notes thereto in the most recent AnnualReport on Form 10-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 period ended March 31,2002 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 SIGNIFICANTACCOUNTING 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 are similar instruments with original maturities in excess of threemonths and are valued at cost, which approximates market. Restrictedcash at March 31, 2003 of $ 15.8 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 analyzeshistorical bad 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 least quarterly, the Companyevaluates the carrying amount of inventory based on the identification ofexcess and obsolete inventory. The Company’s evaluation involves amulti-element approach incorporating the stratification of inventory by timeheld and the stratification of inventory by risk category, among other elements.  The approach incorporates both recenthistorical information and management estimates of trends. The Company’sapproach is intended to take into consideration potential excess andobsolescence caused by a decreasing installed base, engineering changes and endof manufacture.  If any of the elementsof the Company’s estimate were to deteriorate, additional write-downs may berequired. 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.

 

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

 

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.  Thesecurrent and non-current portions of these advances are shown as DeferredRevenue or 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 aconsolidated Federal income tax return. The Company’s foreign subsidiaries fileseparate income tax returns in the countries in which their operations arebased.

 

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 of grant.  The new options willvest as if the tendered options had not been cancelled.

 

IncentiveOptions. During the year ended December 31, 2000, 1,303,460 incentive optionswere granted by the Company. During 2002 and 2003, no additional incentiveoptions were granted.  Under the Plan,incentive options are granted at a fixed exercise price not less than 100% ofthe fair market value of the shares of stock on the date of grant (or 110% ofthe fair market value in certain circumstances). A portion of the incentiveoptions vest over a four-year period at 25% per year beginning January 2, 2001;the remainder vest based on the performance of the Company. As a part 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.

 

Non-qualifiedstock options. During the year ended December 31, 2000, 377,040 non-qualifiedstock options were granted by the Company. During 2002 and 2003, no additionalnon-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 March 31, 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–March 31, 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, and therefore no stock-based compensation was recorded.

 

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,** |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                                                             |   | **2003**                         |   | **2002** |   |
| Net Income (loss)  as reported                                                                                                   |   | $                                | (146   | ) | $ | (9,962 | ) |
| Total stock-based employee compensation  benefit (expense) determined under fair-value-based method for all rewards,  net of tax |   | —                           |   | 330 |   |
| Pro-Forma net  income (loss)                                                                                                     |   | $                                | (146   | ) | $ | (9,632 | ) |

 

**3.**                                      **DISCONCONTINUED 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 twoseparate transactions: (1) the purchase by JAFCO of 100% of the outstandingshares of BTJ for 6.5 billion yen, and (2) a one-time, up-front payment by BTJto the Company 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 monthsended March 31, 2002 was $18.8 million. Pretax income from the discontinued operations of BTJ for the threemonths ended March 31, 2002 was $1.8 million. The assets related to BTJ were previously classified in theInternational segment.

 

**4.**                                      **INVENTORIES**

 

Inventoryconsists of the following:

 
|             |   | **March 31,  2003** |   | **December 31,  2002** |   |
|------------------|--------|---------------------|--------|------------------------|--------|
|             |   | **(In thousands)**  |   |
| Raw materials    |   | $                   | 5,596  |                   | $      | 5,374 |   |
| Work-in-progress |   | 14,959              |   | 9,995                  |   |
| Finished goods   |   | 10,033              |   | 10,159                 |   |
|             |   | $                   | 30,588 |                   | $      | 25,528 |   |

 

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**5.**                                      **PROPERTY, PLANT AND EQUIPMENT**

 

Property,plant and equipment consist of the following:

 
|                                      |   | **March 31,  2003** |   | **December 31,  2002** |   |
|-------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                      |   | **(In thousands)**  |   |
| Land                                      |   | $                   | 2,860  |                   | $      | 2,860 |   |
| Field support spare parts                 |   | 59,331              |   | 58,339                 |   |
| Systems and software                      |   | 66,661              |   | 64,604                 |   |
| Machinery and equipment                   |   | 50,226              |   | 50,053                 |   |
| Furniture, fixtures and other             |   | 23,228              |   | 22,953                 |   |
| Buildings                                 |   | 29,078              |   | 29,006                 |   |
|                                      |   | 231,384             |   | 227,815                |   |
| Accumulated depreciation and amortization |   | 178,236             |   | 173,033                |   |
| Property, plant and equipment, net        |   | $                   | 53,148 |                   | $      | 54,782 |   |

 

**6.**                                      **OTHER ACCRUED EXPENSES AND LIABILITIES**

 

Otheraccrued expenses and liabilities consist of the following:

 
|                                   |   | **March 31,  2003** |   | **December 31,  2002** |   |
|----------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                   |   | **(In thousands)**  |   |
| Salaries, wages and other compensation |   | $                   | 12,163 |                   | $      | 12,169 |   |
| Accrued taxes, other than income taxes |   | 4,891               |   | 8,794                  |   |
| Advances from customers                |   | 1,311               |   | 586                    |   |
| Accrued interest payable               |   | 4,991               |   | 4,951                  |   |
| Accrued invoices and costs             |   | 2,933               |   | 2,395                  |   |
| Accrued contract completion costs      |   | 2,985               |   | 4,590                  |   |
| Other                                  |   | 11,359              |   | 13,398                 |   |
|                                   |   | $                   | 40,633 |                   | $      | 46,883 |   |

 

**7.**                                      **DEBT AND OTHER OBLIGATIONS**

 

Debtand other obligations consist of the following:

 
|                                           |   | **March 31,  2003** |    | **December 31,  2002** |   |
|------------------------------------------------|--------|---------------------|---------|------------------------|--------|
|                                           |   | **(In thousands)**  |    |
| 7.5% Senior Notes, due 2008                    |   | $                   | 94,475  |                   | $      | 97,875 |   |
| Subordinated Sponsor Note, unsecured, due 2009 |   | 103,848             |    | 103,848                |   |
|                                           |   | 198,323             |    | 201,723                |   |
| Less:  Current  portion                   |   | —              |    | —                 |   |
|                                           |   | $                   | 198,323 |                   | $      | 201,723 |   |

 

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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 March 31, 2003, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $13.7million.  The balance remaining underthe Revolver that the Company can draw was $21.6 million at March 31,2003.  A commitment fee of 0.5% perannum on the unused 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%).  AtMarch 31, 2003, the Company’s weighted average rate on the Revolver was 5.75%.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing-base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at March 31, 2003 of $15.8 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 March 31, 2003, the Company was in compliance with all covenants under theRevolver.

 

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 quarter of 2003, the Companyrepurchased Senior Notes with a face amount of $3.4 million. The Company wroteoff a proportionate share of deferred financing-fees, resulting in a gain ofapproximately $1.0 million, which was reported as sundry (other) income in thecondensed consolidated statements of operations for the interim periodsended March 31, 2003.  The estimated fair value of the SeniorNotes as of March 31, 2003, is approximately $60.4 million based on an averagevalue of recently completed market trades, resulting in a yield-to-maturity ofapproximately 18%.  The number of actualtrades is limited; therefore the result may vary if a widely-traded marketenvironment existed.

 

Subordinated Unsecured Sponsor Note.The Company’s $160.0 million Sponsor Note bears interest at 10.0%, due andpayable quarterly. The Sponsor Note is subordinate only upon bankruptcy orinsolvency of the Company, or if upon maturity of the Senior Notes, the SeniorNotes remain unpaid.  The payments beganSeptember 30, 1999. As provided under the agreement, however, the Sponsor Noteholder, WCAS, elected to defer quarterly interest payments of $4.0 million foreach of the September 2000 through September 2001 quarterly periods resultingin an increase 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 March 31,2003, is approximately $59.2 million assuming a yield-to-maturity of 23%.

 

The Company had no outstanding balances onforeign credit agreements at March 31, 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.

 

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**8.**                                      **GOODWILL ANDINTANGIBLE ASSETS**

 

BeginningJanuary 1, 2002, the Company adopted Statement of Financial Accounting Standard(“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (See “New AccountingPronouncements”).  SFAS No. 142 requiresthat goodwill and intangible assets with indefinite useful lives no longer beamortized but instead be tested for impairment at least annually.  SFAS No. 142 also requires that intangibleassets with definite useful lives be amortized over their respective estimateduseful lives to their estimated residual values.

 

SFAS No. 142 requires 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 thethree months ended March 31, 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 March  31, 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 March  31, 2002                     |   | $                   | 41,236 |                                  | $      | —            |   | $               | 240    |      | $      | — |   | $ | 41,476 |   |

 

**9.**                                      **WARRANTY LIABILITY**

 

The Company offers various product warranties for hardware sold to itscustomers.  The specific terms and conditions of the warranties varydepending upon the customer and the product sold.  Factors that affect theCompany’s warranty liability include number of products sold, historical andanticipated rates of warranty claims and cost per claim.  The Companyaccrues for estimated warranty costs as sales are made and periodicallyassesses the adequacy of its recorded warranty liability and adjusts the amountas necessary.

 

Changes to the Company’s warranty liability during the three monthsended March 31, 2003 are summarized as follows:

 
|                                              |   | **(In thousands)** |   |
|---------------------------------------------------|--------|--------------------|--------|
| Balance at  December 31, 2002                     |   | $                  | 139    |   |
| Warranties  issued                                |   | 45                 |   |
| Claims  paid/settlements                          |   | (89                | )      |
| Changes in  liability for pre-existing warranties |   | —             |   |
| Balance at March  31, 2003                        |   | $                  | 95     |   |

 

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**10.**                               **COMPREHENSIVEINCOME (LOSS)**

 

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

 
|                                      |   | **Three Months Ended March 31,** |   |
|-------------------------------------------|--------|----------------------------------|--------|
|                                      |   | **2003**                         |   | **2002** |   |
|                                      |   | **(In thousands)**               |   |
| Net income  (loss)                        |   | $                                | (146   | ) | $ | (9,962 | ) |
| Foreign currency  translation adjustments |   | (103                             | )      | 304 |   |
| Total  comprehensive income (loss)        |   | $                                | (249   | ) | $ | (9,658 | ) |

 

**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 March 31, 2003 |   |               |   |                                  |   |              |   |           |   |      |   |
|                                       |   |               |   |                                  |   |              |   |           |   |      |   |
| Revenue from  external customers           |   | $                  | 32,023 |                                  | $      | 30,820            |   | $              | 27,909 |      | $      | — |   | $ | 90,752 |   |
| Intersegment  revenues                     |   | 544                |   | —                                |   | 1,202             |   | (1,746         | )      | —    |   |
| Segment gross  profits                     |   | 7,084              |   | 5,967                                 |   | 9,427             |   | 10             |   | 22,488    |   |
| Segment operating  income (loss)           |   | 247                |   | 3,833                                 |   | 2,351             |   | (2,384         | )      | 4,047     |   |
| Segment  identifiable assets               |   | 102,339            |   | 29,902                                |   | 54,771            |   | 55,159         |   | 241,361   |   |
| Capital  appropriations                    |   | 915                |   | 210                                   |   | 326               |   | 2,808          |   | 3,867     |   |
|                                       |   |               |   |                                  |   |              |   |           |   |      |   |
| For the three  months ended March 31, 2002 |   |               |   |                                  |   |              |   |           |   |      |   |
|                                       |   |               |   |                                  |   |              |   |           |   |      |   |
| Revenue from  external customers           |   | $                  | 38,799 |                                  | $      | 36,239            |   | $              | 22,243 |      | $      | — |   | $ | 97,281 |   |
| Intersegment  revenues                     |   | 493                |   | —                                |   | 4,964             |   | (5,457         | )      | —    |   |
| Segment gross  profits                     |   | 8,412              |   | 7,626                                 |   | 7,360             |   | (428           | )      | 22,970    |   |
| Segment operating  income (loss)           |   | 539                |   | 3,788                                 |   | 2,009             |   | (2,085         | )      | 4,251     |   |
| Segment  identifiable assets               |   | 113,923            |   | 40,283                                |   | 54,718            |   | 31,642         |   | 240,566   |   |
| Capital  appropriations                    |   | 1,157              |   | 386                                   |   | 335               |   | 181            |   | 2,059     |   |

 

**12.**                               **PREFERRED STOCK**

 

**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 threemonths ended March 31, 2003,accretion of the related discount and accrued but unpaid dividends totaled $0.4million, increasing the carrying amount to $15.3 million. As of March31, 2003, the stated value of the Series Apreferred stock, including accumulated but unpaid dividends, was $178.25 pershare.

 

**SERIES BPREFERRED STOCK**

 

For the three months ended March 31, 2003, the Company accrued additional unpaid dividendsfor its Series B preferred stock totaling $0.5 million, increasing the carryingamount to $8.8 million.  As of March31, 2003, the stated value of the Series Bpreferred stock, including accumulated but unpaid dividends, was $248.80 pershare.

 

**13.**                               **RECENT ACCOUNTING PRONOUNCEMENTS**

 

In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset RetirementObligations.” SFAS No. 143 requires entities to record the fair value of aliability for an asset retirement obligation in the period in which it isincurred. The Company adopted SFAS No. 143 on January 1, 2003 with no impact toits financial position and results of operations.

 

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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 theprovisions of Accounting Principles Board Opinion No. 30, “Reporting theResults of Operations—Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransaction”, are met. The Company adopted the provisions SFAS 145regarding early extinguishment of debt during the second quarter of 2002 andsuch gains are recorded 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 amendment of SFAS No. 123.”  This statement provides alternative methodsof transition for a voluntary change to the fair-value based method ofaccounting for stock-based employee compensation.  This statement also amends the disclosure requirements of SFASNo. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The Company implemented SFAS No. 148 on January 1, 2003, regardingdisclosure requirements for condensed financial statements for interimperiods.  The Company has not yetdetermined whether it will voluntarily change to the fair-value based method ofaccounting 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 is not anticipated to have a material effect on the Company’s results ofoperations or financial position.

 

In November 2002, theFASB’s Emerging Issues Task Force (“EITF”) reached a consensus on Issue 00-21,“Accounting for Revenue Arrangements with Multiple Deliverables,” which must beapplied to all revenue arrangements entered into no later than June 30,2003. However, the EITF is continuing discussion of the applicability of thisIssue to arrangements having one or more elements within the scope of higherlevel accounting literature, including SOP 81-1. 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. If EITF00-21 were applicable to all of the Company’s contracts, the Company would berequired to apply its segmentation criteria, which are different from thosecontained in existing contract accounting literature. Such application couldresult in more segmentation of multiple-element IT services arrangements intoseparate accounting units. The appropriate accounting literature for revenuerecognition would then be applied to each unit. Assuming the segmentationcriteria are met, the accounting for system design and development elements ofmultiple-element IT service contracts similar to those the Company typicallyenters into could use the percentage-of-completion method of revenuerecognition. The accounting for this element, which usually occurs in the earlystages of these contracts, might not change as a result of the EITF. Revenuerecognition for the segmented processing elements would likely occur on anas-billed or straight-line basis. The Company cannot determine the ultimateimpact of EITF 00-21 on its business until the EITF resolves uncertaintiesregarding its scope.

 

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**14.**                               **SUBSEQUENT EVENTS**

 

Since March 31, 2003, the Company repurchasedSenior Notes with a total face amount of $0.5 million. The Company wrote off aproportionate share of deferred financing fees, resulting in a gain ofapproximately $0.1 million, which will be reflected in sundry, net.

 

**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’s Discussionand Analysis of Financial Condition and Results of Operations and Quantitativeand Qualitative Disclosure About Market Risk, contains forward-lookingstatements as that term is defined in the Private Securities Litigation ReformAct of 1995 (the “PSLRA”) that involve risks and uncertainties, as well asassumptions that, if they never materialize or prove incorrect, could cause theresults of BancTec, Inc. and its consolidated subsidiaries (the “Company”) todiffer materially from those expressed or implied by such forward-lookingstatements. All statements other than statements of historical fact arestatements that could be deemed forward-looking statements, including anyprojections of earnings, revenues, or other financial items; any statements ofthe plans, strategies, and objectives of management for future operations; anystatements concerning proposed new products, services, or developments; anystatements regarding future economic conditions or performance; statements ofbelief and any statement of assumptions underlying any of the foregoing. Therisks, uncertainties and assumptions referred to above include the ability ofthe Company to retain and motivate key employees; the timely development,production and acceptance of products and services and their feature sets; thechallenge of managing asset levels, including inventory; the flow of productsinto third-party distribution channels; the difficulty of keeping expensegrowth at modest levels while increasing revenues; and other risks that are describedfrom time to time in the Company’s Securities and Exchange Commission reports,including but not limited to the items discussed in “Factors Affecting theCompany’s Business and Prospects” set forth in this report, and items describedin the Company’s other filings with the Securities and Exchange Commission. TheCompany undertakes no obligation to update or revise forward-looking statementsto reflect changes in assumptions, the occurrence of unanticipated results orchanges to future operating results over time.*

 

The Company believes several factors continued to create a challengingand competitive sales and cost containment environment during the three monthsended March 31, 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 and earningsgrowth prospects.  Most of the Company’sproduct offerings represent a significant capital expenditure for itscustomers.  The general economicconditions have caused a significant weakening in demand for systems solutionsproducts offered by USS and INTL. The Company has concentrated its emphasis oncost reductions and on existing offerings. Product-development efforts arecurrently focused on payment, check and document processing technologies, inaddition to investments in Electronic Document Management (“EDM”) verticalsolutions and an investment in archiving solutions for all markets, as well ashardware enhancements. By incorporating more third-party products into theCompany’s solutions rather than developing the products, the Company can moreeasily target its efforts and expenditures to these core products andsolutions.

 

**RESULTS OF OPERATIONS**

 

**Comparison of Three Months Ended March 31, 2003 and ThreeMonths Ended March 31, 2002**

 

Consolidated revenue of $90.8 million for thethree months ended March 31, 2003 decreased by $6.5 million or 6.7% from thecomparable prior-year period. Decreases in USS of $6.8 million resultedprimarily from the overall weakness in hardware sales.  In addition, USS experienced declines inmaintenance revenue due to Company installed products reaching the end of theiruseful lives and from increased competition. Increases in INTL of $5.7 million are a result of strengthening demandin Europe and the UK for the Company’s software products as well as increasesin maintenance revenue.  A decrease inCNS of $5.4 million resulted from pricing decreases resulting from competitivepressure, as well as decreased volume under certain maintenance programs.  The Company expects these trends to continuein the foreseeable future. Factors impacting future revenue include lowercorporate-customer spending for large systems-solutions as a result of thecontinuing weakness in the economy, customer and prospective customer mergers,on-going competitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $22.5 milliondecreased by $0.5 million or 2.2% from the comparable prior-year period.Decreases in USS of $1.3 million and CNS of $1.6 million were substantiallyoffset by an increase in INTL of $2.4 million. Although USS gross profit decreased due to decreased revenues, the grossprofit percentage increased from 21.7% to 22.1% resulting from the Company’s 

 

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cost-containment efforts. CNS’ gross profitdecrease also resulted primarily from decreased revenues as well asmargin pressure caused by increased competition.  The INTL increase resultedprimarily from increased revenues and an increase in gross profit percentageresulting from cost-containment efforts. The Company is in the process of transitioning its productoffering focus to proven deliverables and new targeted offerings, including EDMsolutions, its other archive solutions and hardware enhancements.  Incorporating more third-party products intothe Company’s solutions rather than developing the products has enabled theconcentration of efforts and expenditures on the targeted items which, alongwith the Company’s ongoing cost-containment efforts, allowed for costreductions to help offset revenue declines.

 

Operating expenses of $18.4 million decreased$0.3 million compared to the comparable prior-year period. Operating expenses,by component, changed as follows: Product-development expenses increased by$0.4 million or 12.1% primarily due to concentration on developing targeted newapplications for the Company’s product lines, selective expansion of existingproducts, and the use of outsourced product-development services. Selling,general, and administrative expenses decreased by $0.7 million or 4.5%due primarily to on-going efforts to realign the cost structure.

 

Interest expense for the three monthsended March 31, 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 $1.2 million during the threemonths ended March 31, 2003 ascompared to a net loss of $0.5 million during the comparable prior-year period. This increase is primarily due to a gain of approximately $1.0 millionfrom the Company’s repurchase of Senior Notes and foreign-exchange gains of$0.2 million during the current-year period, compared to foreign-exchangelosses of $0.4 million in the prior-year period.

 

Pre-tax income in foreign tax jurisdictions resulted in an income taxprovision of $0.6 million for the three months ended March 31, 2003 compared to a corresponding prior-year periodincome tax provision of $0.2 million. The income tax provisions for both periods related to income from theCompany’s international subsidiaries. The Company’s effective tax rate was approximately 130.1% for the threemonths ended March 31, 2003 ascompared to (5.7)% 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 a material impact onthe Company’s future liquidity.

 

The Company’s cash and cash equivalents totaled$44.0 million at March 31, 2003,compared with $31.6 million at December 31, 2002. Working capital increased$1.7 million during the three months ended March 31, 2003 to a working-capital deficit of $7.2 millioncompared to a working-capital deficit of $8.9 million at December 31,2002.  The change in working capitalincluded a current liability increase of $12.2 million from increased deferredrevenue and an accounts receivabledecrease of $6.4 million and an inventory increase of $5.1 million.

 

During the three months ended March 31,2003, the Company relied primarily on cashflows generated from operating activities and short-term borrowings under its revolvingcredit agreement to fund operations. At March31, 2003, the Company had available $39.5million of borrowing capacity under the Revolver, of which the Companycan draw $21.6 million.

 

Operating activities provided $16.8 million and$8.1 million of cash in the three months ended March 31, 2003 and 2002, respectively, an increase of  $8.7 million.  Although net income from continuing operations increased $11.1million, $10.0 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 $8.4 million more than in the prior-year period.

 

Investing activities used net cash of $1.4million and $1.9 million in the three months ended March 31, 2003 and 2002, respectively. Both uses of cashrelated to purchases of property, plant and equipment.

 

Financing activities used $2.8 million and $22.9million of net cash in the three months ended March 31, 2003 and 2002, respectively. The $20.1 million changerelated primarily to the reduction of the Company’s debt.

 

At March 31, 2003, the Company’s principal outstanding debt instrumentsconsisted of (i) no balance outstanding under the revolving credit facility maturingMay 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 

 

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interest on some of its outstanding debt or equity securities.  The Company would only make these paymentsin compliance with the covenants 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 March 31, 2003, the Company had no balance outstanding under theRevolver and an outstanding balance on letters-of-credit totaling $13.7million.  The balance remaining underthe Revolver that the Company can draw was $21.6 million at March 31,2003.  A commitment fee of 0.5% per annumon the unused 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%).  AtMarch 31, 2003, the Company’s weighted average rate on the Revolver was 5.75%.

 

Under the Revolver, substantially all of the Company’s domestic cashreceipts (including proceeds from accounts receivable and asset sales) must beapplied to repay the outstanding loans, which may be re-borrowed subject toavailability in accordance with the borrowing-base formula. The Revolvercontains restrictions on the use of cash for dividend payments or non-scheduledprincipal payments on certain indebtedness. Restricted cash at March 31, 2003 of $15.8 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 March 31, 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 three months ended March 31, 2003, the Companyrepurchased Senior Notes with a face amount of $3.4 million. The Company wroteoff a proportionate share of deferred financing-fees, resulting in a gain ofapproximately $1.0 million, which was reported as sundry (other) income in thecondensed consolidated statements of operations for the three monthsended March 31, 2003.

 

**SubordinatedUnsecured Sponsor Note**. The Company’s $160.0 million SponsorNote bears interest at 10.0%, due and payable quarterly. The Sponsor Note issubordinate only upon bankruptcy or insolvency of the Company, or if uponmaturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. Asprovided under the agreement, however, the Sponsor Note holder, WCAS, electedto defer quarterly interest payments of $4.0 million for each of the September2000 through September 2001 quarterly periods resulting in an increase in theprincipal amount of the Sponsor Note totaling $33.8 million.  Such election required a deferred financing-feeof 30.0% of each of the interest payments being deferred.  The Company accounts for the additionalfinancing fees as a change in the effective interest rate of the debt. WCASmay, at its election, defer each future quarterly payment under similar terms.  WCAS has not elected to defer the quarterlypayments since September 2001.  Inaccordance with the terms of the Sponsor Note, on December 6, 2002, the Companymade a $90.0 million principal payment on the Sponsor Note.  A holder of the Senior Note is contestingthis payment.  See discussion underLegal 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 threemonths ended March 31, 2003,accretion of the related discount and accrued but unpaid dividends totaled $0.4million, increasing the carrying amount to $15.3 million. As of March31, 2003, the stated value of the Series Apreferred stock, including accumulated but unpaid dividends, was $178.25 pershare.

 

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**Preferred Stock – Series B**.****For the three months ended March31, 2003, the Company accrued additionalunpaid dividends for its Series B preferred stock totaling $0.5 million,increasing the carrying amount to $8.8 million.  As of March 31, 2003,the stated value of the Series B preferred stock, including accumulated butunpaid dividends, was $248.80 per share.

 

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

 

**Contractual Obligations andCommercial Commitments.**

In the normal course of business, the Company enters into variouscontractual and other commercial commitments that impact, or could impact, theliquidity of operations. The following table outlines the commitments at March31, 2003:

 
|                              |   | **Total  Amounts** |   | **Less than  1 Year** |   | **1-3  Years** |   | **4-5  Years** |   | **Over 5  Years** |   |
|-----------------------------------|--------|--------------------|--------|-----------------------|--------|----------------|--------|----------------|--------|-------------------|--------|
|                              |   | **(In Millions)**  |   |
| Long-term debt                    |   | $                  | 198.3  |                  | $      | —         |   | $              | — |              | $      | — |   | 198.3 |   |
| Capital leases                    |   | 2.1                |   | 1.0                   |   | 1.1            |   | —         |   | —            |   |
| Operating leases (non-cancelable) |   | 21.2               |   | 7.3                   |   | 7.1            |   | 5.0            |   | 1.8               |   |
| Total Contractual                 |   | 221.6              |   | 8.3                   |   | 8.2            |   | 5.0            |   | 200.1             |   |
|                              |   |               |   |                  |   |           |   |           |   |              |   |
| Unused lines of credit            |   | 21.6               |   | $                     | 21.6   |           | $      | —         |   | $                 | — |   | $ | — |   |
| Standby letters of credit         |   | 13.7               |   | 13.7                  |   | —         |   | —         |   | —            |   |
| Total Commercial                  |   | $                  | 35.3   |                  | $      | 35.3           |   | $              | — |              | $      | — |   | $ | — |   |

 

**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 theprovisions of Accounting Principles Board Opinion No. 30, “Reporting theResults of Operations—Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransaction”, are met. The Company adopted the provisions SFAS 145regarding early extinguishment of debt during the second quarter of 2002 andsuch gains are recorded 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 amendment of SFAS No. 123.”  This statement provides alternative methodsof transition for a voluntary change to the fair-value based method ofaccounting for stock-based employee compensation.  This statement also amends the disclosure requirements of SFASNo. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The Company implemented SFAS No. 148 on January 1, 2003, regardingdisclosure requirements for condensed

 

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financialstatements for interim periods.  TheCompany has not yet determined whether it will voluntarily change to thefair-value based 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 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. However, the EITF is continuingdiscussion of the applicability of this Issue to arrangements having one ormore elements within the scope of higher level accounting literature, includingSOP 81-1. EITF 00-21 governs how to identify whether goods or services or boththat are to be delivered separately in a bundled sales arrangement should beaccounted for separately. If EITF 00-21 were applicable to all of the Company’scontracts, the Company would be required to apply its segmentation criteria,which are different from those contained in existing contract accountingliterature. Such application could result in more segmentation of multiple-elementIT services arrangements into separate accounting units. The appropriateaccounting literature for revenue recognition would then be applied to eachunit. Assuming the segmentation criteria are met, the accounting for systemdesign and development elements of multiple-element IT service contractssimilar to those the Company typically enters into could use thepercentage-of-completion method of revenue recognition. The accounting for thiselement, which usually occurs in the early stages of these contracts, might notchange as a result of the EITF. Revenue recognition for the segmentedprocessing elements would likely occur on an as-billed or straight-line basis.The Company cannot determine the ultimate impact of EITF 00-21 on its businessuntil the EITF resolves uncertainties regarding its scope.

 

**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).

 

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 are unableto 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.

 

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***Declining Financial Operating Results and Indebtedness***

 

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 delivercommercial quantities of new products in a timely manner, that those productswill adhere to generally accepted industry standards or that products willachieve market acceptance. The Company believes that it is necessary for itsproducts to adhere to generally accepted industry standards, which are subjectto change in ways that are beyond the control of the Company.

 

**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 balances wereoutstanding under the Revolver at March 31, 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.

 

**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 audit, some of which are the same weaknessesas noted by D&T in their report.

 

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The Company has addressed certain of the individual internal controlweaknesses noted by D&T and KPMG, but correction of some control factorshas yet to be completed.  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 tocorrect the internal control weaknesses noted by D&T and KPMG, as well asdocument the system of internal controls. Although the Company believes that it has implemented adequate controlsand procedures for the preparation of this report, the adequacy of the actionstaken by the Company to correct certain of the previously identified weaknesseswill not be fully known until the completion of documentation of the Company’ssystem of internal controls.

 

Within the 90 days prior to the filing date of this report, the ChiefExecutive Officer and the Chief Financial Officer of the Company, with theparticipation of the Company’s management, began an evaluation of theeffectiveness of the Company’s disclosure controls and procedures pursuant toExchange Act Rule 13a-14. Based upon the evaluation completed to date, and the new procedures putin place, the Chief Executive Officer and the Chief Financial Officer believethat the Company’s disclosure controls and procedures are effective in makingknown to them material information relating to the Company (including itsconsolidated subsidiaries) required to be included in this report.  The Company will continue to evaluatedisclosure controls on an ongoing basis.

 

Disclosure controls and procedures, no matter how well designed andimplemented, can provide only reasonable assurance of achieving an entity’sdisclosure objectives.  The 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 were no significant changes in the Company’s internal controls orin other factors that could significantly affect internal controls, known tothe Chief Executive Officer or the Chief Financial Officer, subsequent to thedate of the evaluation.

 

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**BANCTEC, INC.**

**PART II**

**OTHER INFORMATION**

**ITEM 1. Legal Proceedings**

 

A lawsuit captioned Cerberus International, Ltd., et al. vs.BancTec, Inc., et al. (Case No. 03600287) was filed on January 28, 2003 inthe Supreme Court of the State of New York for the County of New York naming asdefendants the Company and certain of its affiliates.  The complaintalleges that the Company improperly made a payment to the holder of the SponsorNote.  The complaint seeks damages of not less than $89 million as aresult of the alleged improper payment and the imposition of a constructivetrust on monies paid by the Company to the holder of the Sponsor Note. The Company’s $90 million payment to the holder of the Sponsor Note wasdisclosed in the Company’s Current Report on Form 8-K dated November 27,2002.  This action is in its earliest stages.  The Company believesthat the allegations are without merit and intends to defend against themvigorously.

 

If the lawsuit results in a determination that the payment to reducethe principal amount of the Sponsor Note was in contravention of the terms ofthe Sponsor Note, a position strongly opposed by the Company, under its terms, such payment shallbe held in trust to be paid over to the holders of the Senior Notes, to theextent they remain unpaid.  Therefore, in the event of an unfavorableoutcome in this litigation, there will be no adverse effect on the Company’sfinancial 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.

 

**ITEM 2. Changes in Securities and Useof Proceeds**

 

None

 

**ITEM 3. Defaults Upon SeniorSecurities**

 

None

 

**ITEM 4. Submission of Matters to aVote of Security Holders**

 

None

 

**ITEM5. Other Information**

 

None

 

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

 

 

(a)          Exhibits:

 

10.1– Fifth Amendment to Loan and Security Agreement, dated as of May 7, 2003,between Heller Financial, Inc. and BancTec, Inc.*

 

99.1– Certification of Chief Executive Officer pursuant to 18 USC 1350adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

 

99.2– Certification of Chief Financial Officer pursuant to 18 USC 1350adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

 

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* Filed herewith

 

(b)         Reports onForm 8-K:

 

Current report on Form 8-K/A filed on February 10, 2003, filed for thepurpose of including pro-forma financial information regarding the sale of theCompany's wholly owned subsidiary, BancTec Japan (“BTJ”), disclosed in theCurrent Report on Form 8-K filed November 27, 2002.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Company 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 and Chief* |
|                 |   | *Financial Officer*               |
|                 |   |                              |
| Dated:  May 14, 2003 |   |
|                      |        |                                   |        |  |

 

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**Certifications**

 

I,Craig D. Crisman, certify that:

 

1.             I have reviewed this quarterlyreport on Form 10-Q of BancTec, Inc;

 

2.             Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.             Based on my knowledge, thefinancial statements, and other financial information included in this quarterlyreport, fairly present in all material respects the financial condition,results of operations and cash flows of BancTec, Inc. as of, and for, theperiods presented in this quarterly report.

 

4.             BancTec, Inc.’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrantand have: 

 

a) designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared; 

 

b) evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(the “Evaluation Date”); and 

 

c) presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate; 

 

5.             BancTec, Inc.’s other certifying officers and I havedisclosed, based on our most recent evaluation, to BancTec, Inc.’s auditors andthe audit committee of BancTec, Inc.’s board of directors: 

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and 

 

b) any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and 

 

6.             BancTec, Inc.’s other certifying officers and I haveindicated in this quarterly report whether there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 
| Date:   May 14, 2003 | /s/  Craig D. Crisman                    |   |
|---------------------------|------------------------------------------|--------|
|                      | *Craig D. Crisman*                       |
|                      | *President and Chief Executive  Officer* |

 

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**Certifications**

 

I,Brian R. Stone, certify that:

 

1.             I have reviewed this quarterlyreport on Form 10-Q of BancTec, Inc;

 

2.             Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.             Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of BancTec, Inc. as of, andfor, the periods presented in this quarterly report.

 

4.             BancTec, Inc.’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrantand have: 

 

a) designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared; 

 

b) evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(the “Evaluation Date”); and 

 

c) presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate; 

 

5.             BancTec, Inc.’s other certifying officers and I havedisclosed, based on our most recent evaluation, to BancTec, Inc.’s auditors andthe audit committee of BancTec, Inc.’s board of directors: 

 

a) allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and 

 

b) any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and 

 

6.             BancTec, Inc.’s other certifying officers and I haveindicated in this quarterly report whether there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

 
| Date:   May 14, 2003 | /s/  Brian R. Stone                                  |   |
|---------------------------|------------------------------------------------------|--------|
|                      | *Brian R. Stone*                                     |
|                      | *Senior Vice President and Chief  Financial Officer* |

 

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