UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

ý        Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

 

For the quarterly period ended September 30, 2004

 

OR

 

o        Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

 

Commission File Number 0-9859

 

BANCTEC, INC.

(Exact name of registrant as specified in 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 reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.          Yes  ý     No  o

 

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

 

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

 

Title of Each Class		Number of Shares Outstanding at November 12, 2004
Common Stock, $0.01 par value		17,003,838
Class A Common Stock, $0.01 par value		1,181,946

 

 

PART I

FINANCIAL INFORMATION

ITEM 1.  Financial Statements

BANCTEC, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 (In thousands, except share data)

 

		September 30, 2004			December 31, 2003
		(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents, including restricted cash of $7,046 and $19,578 at September 30, 2004 and December 31, 2003		$	58,698		$	61,566
Accounts receivable, less allowance for doubtful accounts of $972 and $1,126 at September 30, 2004 and December 31, 2003		44,558			39,193
Inventories, net		22,623			23,908
Prepaid expenses		6,324			4,823
Other current assets		42			21
Total current assets		132,245			129,511
PROPERTY, PLANT AND EQUIPMENT, net		37,096			44,832
OTHER ASSETS:
Goodwill		41,476			41,476
Deferred income tax benefit		12,891			13,796
Other assets		5,018			9,900
Total other assets		59,385			65,172
TOTAL ASSETS		$	228,726		$	239,515
CURRENT LIABILITIES:
Current obligations under capital leases		$	567		$	1,105
Trade accounts payable		12,085			13,122
Other accrued expenses and liabilities		47,078			36,901
Deferred revenue		14,570			22,179
Maintenance contract deposits		44,797			44,540
Income taxes		1,832			1,717
Total current liabilities		120,929			119,564
OTHER LIABILITIES:
Long-term debt, less current maturities		197,823			197,823
Non-current maintenance contract deposits		24,175			30,837
Other noncurrent liabilities		16,863			16,750
Total other liabilities		238,861			245,410
Total liabilities		359,790			364,974
COMMITMENTS AND CONTINGENCIES
SERIES A PREFERRED STOCK (Note 3)		—			16,568
SERIES B PREFERRED STOCK (Note 3)		—			10,609
STOCKHOLDERS’ DEFICIT:
Cumulative preferred stock - authorized, 1,000,000 shares of $0.01 par value at September 30, 2004 and December 31, 2003
Series A preferred stock - issued and outstanding,  100,667 shares at September 30, 2004 and December 31, 2003		17,919			—
Series B preferred stock - issued and outstanding,  35,520 shares at September 30, 2004 and December 31, 2003		12,718			—
Common stock authorized, 22,000,000 shares of $0.01 par value at September 30, 2004 and December 31, 2003:
Common stock-issued and outstanding  17,003,838 shares at September 30, 2004 and December 31, 2003		170			170
Class A common stock-issued and outstanding 1,181,946 shares at September 30, 2004 and December 31, 2003		12			12
Subscription stock warrants		3,726			3,726
Additional paid-in capital		123,578			127,038
Accumulated deficit		(274,940		)	(269,020		)
Accumulated other comprehensive loss		(14,247		)	(14,562		)
Total stockholders’ deficit		(131,064		)	(152,636		)
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT		$	228,726		$	239,515

 

See notes to unaudited condensed consolidated financial statements.

 

2

 

BANCTEC, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
		(In thousands)						(In thousands)
REVENUE
Equipment and software		$	27,364		$	37,260		$	101,950		$	110,258
Maintenance and other services		55,753			60,143			170,070			174,940
		83,117			97,403			272,020			285,198
COST OF SALES
Equipment and software		18,912			23,795			66,345			72,510
Maintenance and other services		48,042			49,568			145,792			141,277
		66,954			73,363			212,137			213,787
Gross profit		16,163			24,040			59,883			71,411
OPERATING EXPENSES
Product development		1,833			3,027			6,396			10,419
Selling, general and administrative		13,365			11,281			40,818			41,453
		15,198			14,308			47,214			51,872
Income from operations		965			9,732			12,669			19,539
OTHER INCOME (EXPENSE):
Interest income		193			138			484			547
Interest expense		(4,782		)	(4,945		)	(14,336		)	(14,613		)
Sundry, net		503			173			(1,489		)	1,571
		(4,086		)	(4,634		)	(15,341		)	(12,495		)
INCOME (LOSS) BEFORE INCOME TAXES		(3,121		)	5,098			(2,672		)	7,044
INCOME TAX EXPENSE		328			881			3,248			2,670
NET INCOME (LOSS)		(3,449		)	4,217			(5,920		)	4,374
PREFERRED STOCK DIVIDENDS AND ACCRETION OF DISCOUNT		(1,215		)	(1,025		)	(3,460		)	(2,927		)
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK		$	(4,664	)	$	3,192		$	(9,380	)	$	1,447

 

See notes to unaudited condensed consolidated financial statements.

 

3

 

BANCTEC, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended September 30,
		2004			2003
		(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	(5,920	)	$	4,374
Adjustments to reconcile to cash flows provided by operations:
Depreciation and amortization		12,461			14,348
Provision for doubtful accounts		(159		)	(486		)
Deferred income tax expense		905			—
Loss on disposition of property, plant and equipment		535			536
Gain on extinguishment of long-term debt		—			(1,129		)
Other non-cash items		304			42
Changes in operating assets and liabilities
(Increase) decrease in accounts receivable		(5,206		)	10,706
(Increase) decrease in inventories		1,200			(4,493		)
(Increase) decrease in other assets		455			632
Increase (decrease) in trade accounts payable		(1,037		)	2,651
Increase (decrease) in deferred revenue & maintenance contracts deposits		(6,696		)	7,800
Increase in other accrued expenses and liabilities		3,118			(3,648		)
Cash flows provided by (used in) operating activities		(40		)	31,333
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant and equipment		(5,421		)	(4,656		)
Proceeds from sale of property, plant and equipment		297			—
Proceeds from sale of investment in unconsolidated subsidiary		2,955			—
Cash flows used in investing activities		(2,169		)	(4,656		)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of current maturities of long-term debt and capital lease obligations		(865		)	(858		)
Payments on long-term borrowing		—			(2,752		)
Debt issuance costs		(50		)	(95		)
Cash flows used in financing activities		(915		)	(3,705		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH		256			395
NET INCREASE IN CASH AND CASH EQUIVALENTS		(2,868		)	23,367
CASH AND CASH EQUIVALENTS-BEGINNING OF YEAR		61,566			31,595
CASH AND CASH EQUIVALENTS-END OF PERIOD		$	58,698		$	54,962
SUPPLEMENTAL DISCLOSURES INFORMATION:
Cash paid (refunded) during the period for:
Interest		$	11,574		$	13,588
Taxes		$	2,196		$	(160	)

 

See notes to unaudited condensed consolidated financial statements.

 

4

 

BANCTEC, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.                                      NATURE OF BUSINESS AND BASIS OF PRESENTATION

 

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

 

The accompanying unaudited condensed consolidated balance sheet at September 30, 2004, and the unaudited condensed consolidated statements of operations and cash flows for the interim periods ended September 30, 2004 and 2003, should be read in conjunction with BancTec, Inc. and subsidiaries (“BancTec” or the “Company”) consolidated financial statements and notes thereto in the most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission.   In the opinion of management, the accompanying condensed consolidated financial statements contain all material adjustments, consisting principally of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations of the Company. All significant intercompany balances and transactions have been eliminated in consolidation.

 

2.                                      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

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

 

Cash and Cash Equivalents and Short-Term Investments

 

Cash and cash equivalents include cash on hand and on deposit, including highly liquid investments with original maturities of three months or less. Short-term investments or similar instruments with original maturities in excess of three months are valued at cost, which approximates market. Restricted cash at September 30, 2004, of $7.0 million represents the cash pledged under the terms of the Revolver.

 

Allowance for Doubtful Accounts

 

The allowance for doubtful accounts is an estimate prepared by management based on evaluation of the collectibility of specific accounts and the overall condition of the receivable portfolios. The Company analyzes trade receivables, and analyzes historical bad debts, customer credits, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts. The allowance for doubtful accounts is reviewed periodically and adjustments are recorded as deemed necessary.

 

Inventories

 

Inventories are valued at the lower of cost or market and include the cost of replacement parts, raw materials, labor, factory overhead, and purchased subassemblies. Cost is determined using the first-in, first-out and weighted average methods. At least quarterly, the Company evaluates the carrying amount of inventory based on the identification of excess and obsolete inventory. The Company’s evaluation involves a multi-element approach incorporating the stratification of inventory by time held and the stratification of inventory by risk category, among other elements.  The approach incorporates both recent historical information and management estimates of trends. The Company’s approach is intended to take into consideration potential excess and obsolescence caused by a decreasing installed base, engineering changes and end of manufacture.  If any of the elements of the Company’s estimate were to deteriorate, write-downs may be required. The inventory write-down calculations are reviewed periodically and additional write-downs are recorded as deemed necessary.  Inventory reserves as of September 30, 2004, and December 31, 2003, were $14.0 million and $15.0 million respectively.  Inventory reserves establish a new cost basis for inventory and are not reversed in future periods.

 

Property, Plant, and Equipment

 

Property, plant, and equipment are recorded at cost and are depreciated or amortized principally on a straight-line basis over the estimated useful lives of the related assets. Estimated useful lives range from three to five years for field support spare parts, three to eight years for systems and software, five to seven years for machinery and equipment, leasehold improvements, and furniture and fixtures. Buildings are depreciated over 40 years.   Depreciation expense for the nine months ended September 30, 2004 and 2003 was $12.5 million and $14.3 million respectively.

 

5

 

Revenue Recognition

 

The Company derives revenue primarily from two sources: 1) product sales- hardware and software which address complex data and paper-intensive work processes, including advanced web-enabled imaging and workflow 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, including field 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 to Certain Transactions” to all transactions involving the sale of software products and sales of hardware where the software is not incidental. For those transactions that involve acceptance certificates, the Company recognizes revenue upon receipt of the acceptance certificate, or when it can be objectively demonstrated that acceptance criteria have been met.  For hardware transactions where software is considered incidental, or no software is included, revenue is recognized when the product has been delivered and all obligations have been fulfilled.

 

The Company recognizes revenue from sales of equipment and supplies upon delivery and transfer of title or upon customer acceptance.

 

The Company recognizes hardware and software revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable. At the time of the transaction, the Company determines whether the fee associated with revenue transactions is fixed or determinable and whether or not collection is reasonably assured. The Company determines whether the fee is fixed or determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after the normal payment terms, which are generally 30 days from invoice date, the Company recognizes revenue as the fees are collected. The Company assesses collectibility based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. The Company does not request collateral from customers. If the Company determines that collection of the fee is not reasonably assured, the Company defers the revenue and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash. For all sales, the Company generally uses either a binding purchase order or signed sales agreement as evidence of an arrangement.

 

Maintenance contracts are primarily at least one year in duration and the revenue generated is generally recognized ratably over the term of the contract.

 

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

 

Research and Development

 

Research and development costs are expensed as incurred.   Research and development costs for the nine months ended September 30, 2004, and 2003, were $6.4 million and $10.4 million respectively.

 

Income Taxes

 

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

 

Income taxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The Company records valuation allowances related to its deferred income tax assets when, in the opinion of management, it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Foreign Currency Translation

 

Foreign assets and liabilities are translated using the exchange rate in effect at the balance sheet date, and results of operations are translated using an average rate for the period. Translation adjustments are accumulated and reported as a component of stockholders’

 

6

 

deficit and comprehensive income (loss). Transaction gains and losses are included in results of operations in “Sundry, net”.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB No. 25”), Accounting for Stock Issued to Employees. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards (“SFAS No. 123”), Accounting for Stock-Based Compensation.

 

2000 Stock Plan:

 

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

 

Incentive Options. During the year ended December 31, 2003, the Company granted 45,000 incentive options.  During the nine months ended September 30, 2004, 1,379,550 incentive options were granted.  Under the Plan, incentive options are granted at a fixed exercise price not less than 100% of the fair market value of the shares of stock on the date of grant (or 110% of the fair market value in certain circumstances). A portion of the incentive options vest over a four-year period at 25% per year beginning January 2, 2001; the remainder vest based on the performance of the Company. As a part of an employee retention program, vesting of 20.0% of the performance-based incentive options was accelerated in October 2000.

 

Non-qualified stock options. During the year ended December 31, 2003, no non-qualified options were granted.  During the nine months ended September 30, 2004, the Company granted 50,000 non-qualified stock options.  Under the Plan, non-qualified options are granted at a fixed exercise price equal to, more than, or less than 100% of the fair market value of the shares of stock on the date of grant. The non-qualified options granted in 2000 vest partially 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 an employee retention program, vesting of 20.0% of the performance-based incentive options was accelerated in October 2000.

 

		Incentive Shares		Non-qualified Shares		Weighted Average Exercise Price
Options outstanding–December 31, 2002		497,240		31,760		9.25
Granted		45,000		—		9.25
Forfeited		(60,000	)	—		9.25
Options outstanding–December 31, 2003		482,240		31,760		9.25
Granted		1,379,550		50,000		9.25
Forfeited		(121,500	)	(50,000	)	9.25
Options outstanding–September 30, 2004		1,740,290		31,760		9.25

 

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

 

At September 30, 2004, options to purchase 1,772,050 shares were outstanding, of which 226,500 were vested.  All options outstanding have an exercise price of $9.25.  No options have been exercised.

 

Under the intrinsic-value method, compensation expense is recorded only to the extent that the strike price is less than market price on the measurement date.  All options granted in 2003 and 2004 were issued at or above market price, and therefore no stock-based compensation was recorded.

 

7

 

The following table illustrates the effect on net income as if compensation for the Company’s stock option plans had been determined in conformance with SFAS No. 123:

 

		Nine Months Ended September 30,
		2004			2003
Net income (loss) as reported		$	(5,920	)	$	4,374
Total stock-based employee compensation expense determined under fair-value-based method for all rewards, net of tax		(42		)	12
Pro Forma net income (loss)		$	(5,962	)	$	4,386

 

3.                                      RECLASSIFICATION, IMPAIRMENT AND CHANGE IN ACCOUNTING ESTIMATE

 

Reclassification

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

 

The Company has two issues of Preferred Stock as described in Note 14 – Preferred Stock, contained in Notes to the Condensed Consolidated Financial Statements.  Series A Preferred Stock has been historically classified in the mezzanine section of the Consolidated Balance Sheets due to the provision providing for mandatory redemption.  On March 31, 2004, the Board of Directors and the holder of the Series A Preferred Stock approved an amendment to the Series A Preferred Stock agreement to remove the mandatory redemption provision.

 

Both the Series A Preferred and the Series B Preferred include provisions for redemption at the option of holders in certain circumstances including a sale or merger of the Company and redemption at the option of the Company.  At December 31, 2003, the Series B Preferred was classified in the mezzanine section as provided by guidance contained in EITF Topic D-98, “Classification and Measurement of Redeemable Securities.”  Under this guidance, classification in the permanent equity section is not considered appropriate if the preferred stock is redeemable upon majority vote of the Board of Directors and such board is controlled by the preferred security holders.  At December 31, 2003, preferred security holders comprised 50% of the Board of Directors.  On March 31, 2004, the Board of Directors elected a seventh member who is not a preferred security holder.  As a result of the removal of the mandatory redemption provisions for Series A Preferred Stock and the addition of the seventh board member whereby the preferred security holders no longer control the Board of Directors, the Series A and Series B Preferred Stock are being reclassified into the permanent equity section of the Consolidated Balance Sheets at September 30, 2004.

 

Impairment

The Company’s investments in non-marketable equity securities is monitored for impairment and is written down to fair value with a change to earnings if a decline in fair value is judged to be other than temporary.  During the second quarter of 2004, the Company recorded a write down of approximately $1.5 million to reflect the estimated fair value of $2.7 million in its investment in the stock of Servibanca S.A. (43.4% interest), which is accounted for as an equity investment.  The sale of this stock, at a net sales price of $2.7 million was completed in August 2004.  The impairment charge of $1.5 million is reflected in Sundry, net in the Condensed Consolidated Statements of Operations for the nine months ended September 30, 2004.

 

4.                                      SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING TRANSACTIONS

 

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

 

		Nine months Ended September 30,
		2004			2003
		(In thousands)
Capital lease obligation incurred for lease of computer hardware		$	241		$	2,049
Inventory put in service as fixed asset		105			1,857

 

8

 

5.                                      INVENTORIES

 

Inventory consists of the following:

 

		September 30, 2004			December 31, 2003
		(In thousands)
Raw materials & replacement parts		$	9,792		$	6,035
Work-in-progress		5,395			7,168
Finished goods		7,436			10,705
		$	22,623		$	23,908

 

6.                                      PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consist of the following:

 

		September 30, 2004			December 31, 2003
		(In thousands)
Land		$	2,860		$	2,860
Field support spare parts		59,163			59,789
Systems and software		60,139			58,927
Machinery and equipment		21,000			21,075
Furniture, fixtures and other		19,211			19,514
Buildings		27,727			27,653
		190,100			189,818
Accumulated depreciation and amortization		153,004			144,986
Property, plant and equipment, net		$	37,096		$	44,832

 

7.                                      OTHER ACCRUED EXPENSES AND LIABILITIES

 

Other accrued expenses and liabilities consist of the following:

 

		September 30, 2004			December 31, 2003
		(In thousands)
Salaries, wages and other compensation		$	12,480		$	12,843
Accrued taxes, other than income taxes		5,000			5,312
Advances from customers		8,225			907
Accrued interest payable		4,963			3,211
Accrued invoices and costs		1,537			2,114
Other		14,873			12,514
		$	47,078		$	36,901

 

9

 

8.                                      DEBT AND OTHER OBLIGATIONS

 

Debt and other obligations consist of the following:

 

		September 30, 2004			December 31, 2003
		(In thousands)
7.5% Senior Notes, secured, due 2008		$	93,975		$	93,975
Sponsor Note, unsecured, due 2009		103,848			103,848
Revolving Credit Facility, secured, due 2006		—			—
		197,823			197,823
Less: Current portion		—			—
		$	197,823		$	197,823

 

Revolving Credit Facility.  The Company has a revolving credit facility (the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which matures on May 30, 2006.  Effective May 7, 2003, the Company and Heller entered into an amendment to the Revolver which reduced the committed amount from $60 million to $40 million, while increasing the letter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially all the assets of the Company, subject to the limitations on liens contained in the Company’s existing Senior Notes.   Funds availability under the Revolver is determined by a borrowing-base formula equal to a specified percentage of the value of the Company’s eligible accounts receivable, inventory and pledged cash.  At September 30, 2004, the Company had no balance outstanding under the Revolver and an outstanding balance on letters-of-credit totaling $7.0 million.  The balance remaining under the Revolver that the Company can draw was $16.1 million at September 30, 2004 ($20.1 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on the unused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’s option, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Under an amendment effective September 1, 2003, the interest rate margins over prime and LIBOR may be increased by 0.25% increments when the fixed charge coverage ratio falls below (1) 2.0 to 1.0, (2) 1.75 to 1.0, (3) 1.5 to 1.0 and (4) 1.25 to 1.0 and (total rate increase of 1.00%) or decreased by 0.25% increments when the fixed charge coverage ratio is greater than 2.25 to 1.0 (total rate decrease of 0.25%).  At September 30, 2004, the Company’s rate on the Revolver was 5.75%.

 

Under the Revolver, substantially all of the Company’s domestic cash receipts (including proceeds from accounts receivable and asset sales) must be applied to repay the outstanding loans, which may be re-borrowed subject to availability in accordance with the borrowing base formula. The Revolver contains restrictions on the use of cash for dividend payments or non-scheduled principal payments on certain indebtedness.  Restricted cash at September 30, 2004 of $7.0 million represents cash pledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties and covenants, including financial covenants as to maximum capital expenditures, minimum fixed charge coverage ratio and minimum average borrowing availability.  At September 30, 2004, the Company was in compliance with all covenants under the Revolver.

 

Senior Notes.  Interest on the Senior Notes is fixed at 7.5% and is due and payable in semi-annual installments. Payments began December 1, 1998. The Notes contain covenants placing limitations on the Company’s ability to permit subsidiaries to incur certain debts, incur certain loans, and engage in certain sale and leaseback transactions. During the first six months of 2003, the Company repurchased Senior Notes with a face amount of $3.9 million. The Company wrote off a proportionate share of deferred financing-fees, resulting in a gain of approximately $1.1 million, which was reported as sundry (other) income in the condensed consolidated statements of operations for the interim period ended June 30, 2003.  The estimated fair value of the Senior Notes as of September 30, 2004, is approximately $66.9 million based on an average value of the most recently completed market trades, resulting in a yield-to-maturity of approximately 21%.  The number of actual trades is limited; therefore the result may vary if a widely traded market environment existed.

 

Unsecured Sponsor Note. The Company’s Sponsor Note bears interest at 10.0%, due and payable quarterly. The Sponsor Note is subordinate only upon bankruptcy or insolvency of the Company, or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. As provided under the agreement, however, the Sponsor Note holder, Welsh, Carson, Anderson & Stowe (“WCAS’), elected to defer quarterly interest payments of $4.0 million for each of the September 2000 through September 2001 quarterly periods resulting in an increase in the principal amount of the Sponsor Note totaling $33.8 million. 

 

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Such election required a deferred financing-fee of 30.0% of each of the interest payments being deferred.  The Company accounts for the additional financing fees as a change in the effective interest rate of the debt. WCAS may, at its election, defer each future quarterly payment under similar terms.  WCAS has not elected to defer 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 Sponsor Note.  A holder of the Senior Notes has sought to contest this payment.  See discussion under Legal Proceedings.  The estimated fair-value of the Sponsor Note and deferred interest and fees as of September 30, 2004, is approximately $60.2 million assuming a yield-to-maturity of 26%.

 

The Company had no outstanding balances on foreign credit agreements at September 30, 2004.

 

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

 

9.                                      GOODWILL AND INTANGIBLE ASSETS

 

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

 

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

 

Goodwill previously classified as unallocated has been allocated to the reporting units as required by SFAS No. 142.  There were no changes in the carrying amount of goodwill by segment for the nine months ended September 30, 2004 or September 30, 2003.

 

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10.                               TAXES

 

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below (dollars in thousands):

 

		September 30, 2004			December 31, 2003
		(In thousands)
Gross deferred tax assets:
Net operating losses		$	41,300		$	38,106
AMT credit carryforwards		102			328
Inventory reserves		5,036			5,360
Receivable allowance		196			301
Intangible assets previously deducted		1,014			1,341
Deferred revenues		15,750			23,152
Deferred compensation		3,688			2,443
Foreign timing differences, net		3,543			3,835
Taxes paid on intercompany profits		1,137			938
Other		4,416			5,129
Total gross deferred tax asset		76,182			80,933
Gross deferred tax liabilities:
Depreciation		(1,235		)	(1,646		)
Undistributed earnings of foreign subsidiaries		(5,837		)	—
Other		—			(679		)
Total gross deferred tax liability		(7,072		)	(2,325		)
Deferred tax asset valuation reserve		(56,219		)	(64,812		)
Net deferred tax asset		$	12,891		$	13,796

 

A valuation allowance has been provided to reduce the deferred tax assets to an amount management believes is more likely than not to be realized. Expected realization of deferred tax assets for which a valuation allowance has not been recognized is based upon the reversal of existing taxable temporary differences and taxable income expected to be generated in the future.  The valuation allowance for deferred tax assets as of September 30, 2004 and December 31, 2003 was $56,219,000 and $64,812,000, respectively.  The net change in the total valuation allowance for the nine months ended September 30, 2004 was a decrease of $8,593,000, consisting of a $5,837,000 decrease related to the recording of a deferred tax liability on the undistributed earnings of two foreign subsidiaries, a decrease of $2,039,000 related to the true up to the 2003 Income Tax Return and a decrease of $717,000 related to continuing operations.

 

Undistributed earnings of foreign subsidiaries included in continuing operations were approximately $26.4 and $35.9 million at September 30, 2004 and December 31, 2003, respectively. Taxes have been provided on the undistributed earnings of two subsidiaries, BancTec Limited and BancTec Holding N.V., as specified by APB 23, “Accounting for Income Taxes—Special Areas,” due to the distribution of dividends from these subsidiaries during the nine months ended September 30 2004.  No taxes have been provided for the other subsidiaries as they are considered to be permanently reinvested.

 

11.                               WARRANTY LIABILITY

 

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

 

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Changes to the Company’s warranty liability, which is reported as a component of other accrued expenses and liabilities in the accompanying condensed consolidated balance sheet during the nine months ended September 30, 2004 are summarized as follows:

 

		(In thousands)
Balance at December 31, 2003		$	140
Warranties issued		90
Claims paid/settlements		(67		)
Changes in liability for pre-existing warranties		17
Balance at September 30, 2004		$	180

 

12.                               COMPREHENSIVE LOSS

 

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

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
		(In thousands)						(In thousands)
Net income (loss)		$	(3,449	)	$	4,217		$	(5,920	)	$	4,374
Foreign currency translation adjustments		3			132			315			769
Total comprehensive income (loss)		$	(3,446	)	$	4,349		$	(5,605	)	$	5,143

 

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13.                               BUSINESS SEGMENT DATA

 

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

 

		US Solutions			Computer & Network Services			International			Corp/Elims			Total
		(In thousands)
For the three months ended September 30, 2004
Revenue from external customers		$	24,287		$	32,363		$	26,467		$	—		$	83,117
Intersegment revenue		759			—			2,500			(3,259		)	—
Segment gross profits		5,620			2,200			8,609			(266		)	16,163
Segment operating income (loss)		1,124			296			1,484			(1,939		)	965
For the three months ended September 30, 2003
Revenue from external customers		$	34,803		$	34,889		$	27,711		$	—		$	97,403
Intersegment revenue		568			—			1,965			(2,533		)	—
Segment gross profits		8,815			5,126			10,380			(281		)	24,040
Segment operating income (loss)		3,107			3,065			4,962			(1,402		)	9,732
For the nine months ended September 30, 2004
Revenue from external customers		$	84,437		$	97,714		$	89,869		$	—		$	272,020
Intersegment revenue		2,231			—			6,463			(8,694		)	—
Segment gross profits		19,450			9,068			31,875			(510		)	59,883
Segment operating income (loss)		4,620			3,030			10,931			(5,912		)	12,669
Segment identifiable assets		76,839			25,492			50,966			75,429			228,726
Capital appropriations		1,509			1,797			1,297			1,164			5,767
For the nine months ended September 30, 2003
Revenue from external customers		$	105,417		$	98,656		$	81,125		$	—		$	285,198
Intersegment revenue		1,674			—			5,035			(6,709		)	—
Segment gross profits		24,512			17,988			28,917			(6		)	71,411
Segment operating income (loss)		5,732			11,542			9,323			(7,058		)	19,539
Segment identifiable assets		94,821			27,824			54,025			64,354			241,024
Capital appropriations		1,820			1,082			3,138			2,522			8,562

 

14.                               PREFERRED STOCK

 

SERIES A PREFERRED STOCK

 

The Company allocated the proceeds from its Series A preferred stock issuance based upon the relative fair value of the preferred stock and warrants issued.  The related discount is being accreted over a period of eight years.  For the nine months ended September 30, 2004, accretion of the related discount and accrued but unpaid dividends totaled $1.4 million, increasing the carrying amount to $17.9 million. As of September 30, 2004, the stated value of the Series A preferred stock, including accumulated but unpaid dividends, was $197.83 per share.

 

SERIES B PREFERRED STOCK

 

For the nine months ended September 30, 2004, the Company accrued additional unpaid dividends for its Series B preferred stock totaling $2.1 million, increasing the carrying amount to $12.7 million.  As of September 30, 2004, the stated value of the Series B preferred stock, including accumulated but unpaid dividends, was $358.05 per share.

 

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15.                               RECENT ACCOUNTING PRONOUNCEMENTS

 

In June 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of a nonpublic entity.  For mandatorily redeemable financial instruments of a nonpublic entity, this statement shall be effective for fiscal periods beginning after December 15, 2003.  The Company has adopted SFAS No. 150 with no effect on the Company’s results of operations or financial position.

 

16.          SUBSEQUENT EVENTS

 

None

 

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

 

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

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosure About Market Risk, contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause the results of BancTec, Inc. and its consolidated subsidiaries (the “Company”) to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact could be deemed forward-looking statements, including any projections of earnings, revenues, or other financial items; any statements of the plans, strategies, and objectives of management for future operations; any statements concerning proposed new products, services, or developments; any statements regarding future economic conditions or performance; statements of belief and any statement of assumptions underlying any of the foregoing. The risks, uncertainties and assumptions referred to above include technological improvements that reduce the market for paper-handling products, the ability of the Company to retain and motivate key employees; the timely development, production and acceptance of products and services and their feature sets; the challenge of managing asset levels, including inventory; the flow of products into third-party distribution channels; the difficulty of keeping expense growth at modest levels while increasing revenues; and other risks that are described from time to time in the Company’s Securities and Exchange Commission reports, including but not limited to the items discussed in “Factors Affecting the Company’s Business and Prospects” set forth in this report, and items described in the Company’s other filings with the Securities and Exchange Commission. The Company undertakes no obligation to update or revise forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated results or changes to future operating results over time.

 

Overview

 

The Company believes several factors continued to create a challenging and competitive sales and cost-containment environment during the nine months ended September 30, 2004.  These factors include: the impact of check truncation, reduced corporate customer technology spending; ongoing competitive pressures; an ongoing planned change in revenue mix within the Company’s U.S. Solutions (“USS”) and International Solutions (“INTL”) segments; and a highly leveraged financial position.  The change in revenue mix is partially a result of trends in payment processing, including truncation, which impacts domestic and international markets.  Additionally, during the nine months ended September 30, 2004, the USS and INTL segments experienced revenue declines in the maintenance business, the duration of which the Company cannot predict.

 

Computer and Network Services (“CNS”) encounters aggressive competition from a variety of companies.  The Company believes that functionality, performance, quality, service, and price are important competitive factors in the markets in which it operates.  While the Company believes that its offerings compete favorably based on each of these elements, the Company could be adversely affected if its competitors offer their products at significantly lower prices than the Company.

 

Expected economic and business conditions into the remainder of 2004 indicate a cautious outlook regarding the Company’s near-term revenue and earnings growth prospects.  The passage of the Check Clearing for the 21^st Century Act (“Check 21”), to allow for the truncation of checks, is expected to result in decreased demand for payment and check clearing solutions.  The Company has concentrated on cost reductions and on document processing solutions.  Product-development efforts are being focused on document processing technologies, including Electronic Document Management (“EDM”) vertical solutions and high-speed, full-page scanners, as well as continued hardware enhancements. By incorporating more third-party products into the Company’s solutions rather than developing the products, the Company can more easily target its efforts and expenditures to these core products and solutions.

 

RESULTS OF OPERATIONS

 

Comparison of Three Months Ended September 30, 2004 and Three Months Ended September 30, 2003

 

Consolidated revenue of $83.1 million for the three months ended September 30, 2004 was a decrease of $14.3 million or 14.7% from the comparable prior-year period.  The USS revenue decrease of $10.5 million was partially related to a decline in maintenance revenue due to the Company’s installed products reaching the end of their useful lives and from increased competition.  The Company expects these trends to continue in the foreseeable future.  In addition, a decline in revenue related to the sale and installation of hardware and software products was primarily related to a weak market for payments solutions due to market trends, including reduced check volume, check truncation, and the recent passage of Check 21.  Decreases in INTL of $1.2 million are the result of reduced deliveries of solutions to customers partially offset by the impact of the weakening dollar on the conversion of revenue stated in foreign currencies and the continued growth of document processing services in the United Kingdom.  The CNS decrease of $2.5

 

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million with the comparable prior-year period primarily resulted from pricing decreases, domestic competitive pressure, and decreased volume under certain maintenance programs.  These decreases were somewhat offset by the expansion by CNS of operations in Europe.

 

Factors expected to impact future revenue include corporate-customer spending for large systems-solutions, the continued impacts of check truncation, customer and prospective customer mergers, on-going competitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $16.2 million decreased by $7.8 million or 32.5% from the comparable prior-year period. Decreases were experienced in CNS of $2.9 million, USS of $3.2 million and in INTL of $1.8 million. The decrease in USS gross profit resulted primarily from decreased revenues.  In addition, the USS gross margin percentage decreased from 24.9% to 22.3%, resulting from competitive pricing pressures.  The decreases in INTL gross profit resulted from decreased revenue and a lower gross profit percentage, decreasing from 35.0% to 29.7%, which were partially offset by the impact of currency conversion.  CNS’ gross profit percentage decreased from 14.6% to 6.8%, resulting primarily from decreased revenue, margin reduction caused by competitive pricing pressure and losses experienced under certain service contracts.  CNS is the major component in the maintenance and other services category on the Consolidated Statements of Operations, and therefore is the primary contributing factor in the decreased gross profit in the maintenance and other services category.

 

Operating expenses of $15.2 million increased $0.9 million compared to the prior-year period. Operating expenses, by component, changed as follows: Product-development expenses decreased by $1.2 million or 40.0% primarily due to the focused realignment of research and development expenditures against future product strategies and marketing plans.  The use of outsourced product-development services also contributed to the reduction. Selling, general and administrative expenses (“SG&A”) increased by $2.1 million or 18.6%.  This increase partially resulted from additional marketing expenditures aimed at new product strategies.  Also, the prior year period included a reduction in net expenses related the receipt of certain property tax refunds.

 

Interest expense for the three months ended September 30, 2004 of $4.8 million decreased $0.1 million from the comparable prior-year period.

 

Sundry items resulted in a net gain of $0.5 million during the three months ended September 30, 2004.  This gain is primarily the result of foreign-exchange gains.  This is compared to a net gain of $0.2 million recorded during the comparable prior-year period, also consisting primarily of foreign-exchange gains.

 

An income tax provision of $0.3 million for the three months ended September 30, 2004 is compared to a corresponding prior-year period income tax provision of $0.9 million.  The income tax provisions for both periods related primarily to income from the Company’s international subsidiaries.  The Company’s effective tax rate was approximately (10.5)% for the three months ended September 30, 2004 as compared to 17.3% for the corresponding prior-year period.

 

Comparison of Nine Months Ended September 30, 2004 and Nine Months Ended September 30, 2003

 

Consolidated revenue of $272.0 million for the nine months ended September 30, 2004 decreased by $13.2 million or 4.6% from the comparable prior-year period. The USS revenue decrease of $21.0 million was partially related to a decline in maintenance revenue due to the Company’s installed products reaching the end of their useful lives and from increased competition.  The Company expects these trends to continue in the foreseeable future.  In addition, a decline in revenues related to the sale and installation of hardware and software products was primarily related to a weak market for payments solutions due to market trends, including reduced check volume, check truncation, and the recent passage of Check 21.  Increases in INTL of $8.8 million are the result of the impact of the weakening dollar on the conversion of revenue stated in foreign currencies and the continued growth in the United Kingdom of document processing services.  A decrease in CNS of $1.0 million resulted from pricing decreases, domestic competitive pressure, and decreased volume under certain maintenance programs, partially offset by revenue increases resulting from the expansion by CNS of operations into Europe.  Factors expected to impact future revenue include corporate-customer spending for large systems-solutions, the continued impacts of check truncation, customer and prospective customer mergers, on-going competitive pressures, and fluctuations in international currencies.

 

Consolidated gross profit of $59.9 million decreased by $11.5 million or 16.1% from the comparable prior-year period. Decreases in CNS of $8.9 million and USS of $5.0 million were partially offset by increases in INTL of $3.0 million.  The decrease in USS resulted from decreased revenues as well as a decrease in the USS gross margin percentage from 22.9% to 22.5%.  Increases in INTL gross profit resulted partially from increased revenue, including the impact of currency conversion, offset partially by a lower gross profit percentage, decreasing from 33.6% to 33.1%. Continued efforts to provide proven deliverables as well as targeted new offerings, including EDM solutions, archive solutions and hardware enhancements, which, along with ongoing cost-containment efforts, allowed for cost reductions to strengthen the INTL gross profit.  CNS’ gross profit percentage decreased from 18.2% to 9.3%, resulting primarily from decreased revenue, margin reduction caused by competition pricing pressure and losses experienced under certain service contracts.  CNS is the major component in the maintenance and other services category on the Consolidated Statements of

 

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Operations, and therefore is the primary contributing factor in the decreased gross profit in the maintenance and other services category.

 

Operating expenses of $47.2 million decreased $4.7 million compared to the prior-year period. Operating expenses, by component, changed as follows: product-development expenses decreased by $4.0 million or 38.5% primarily due to the focused realignment of research and development expenditures against future product strategies and marketing plans.  The use of outsourced product-development services also contributed to the reduction. SG&A decreased by $0.7 million or 1.7% due to decreased SG&A depreciation expense and on-going efforts to realign the cost structure.

 

Interest expense for the nine months ended September 30, 2004 of  $14.3 million decreased $0.3 million from the comparable prior-year period.

 

Sundry items resulted in a net loss of $1.5 million during the nine months ended September 30, 2004 compared to a net income of $1.6 million during the comparable prior-year period.  This decrease is primarily due to foreign-exchange losses of $0.3 million and the $1.3 million loss on the sale of 100% of the Company’s investment in the stock of Servibanca S.A. during the current-year period, compared to a gain from the repurchase of Senior Notes of approximately $1.1 million and foreign-exchange gains of $0.4 million in the prior-year period.

 

An income tax provision of $3.2 million for the nine months ended September 30, 2004 is compared to a corresponding prior-year period income tax provision of $2.7 million.  The income tax provision for the period related primarily to income of approximately $8.7 million from the Company’s international subsidiaries.  The Company’s effective tax rate was approximately (121.6)% for the nine months ended September 30, 2004 as compared to 37.9% for the corresponding prior-year period.

 

LIQUIDITY AND CAPITAL RESOURCES

 

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

 

The Company’s cash and cash equivalents totaled $58.7 million at September 30, 2004 compared with $61.6 million at December 31, 2003. Working capital increased $1.4 million during the nine months ended September 30, 2004 to working capital of $11.3 million compared to working capital of $9.9 million at December 31, 2003.  The change in working capital included a current liability increase of $1.3 million from increased accrued liabilities partially offset by decreases in deferred revenue and maintenance contract deposits and accounts payable, a decrease in net inventories of $1.3 million, an accounts receivable increase of $5.4 million and a prepaid expense increase of $1.5 million.

 

During the nine months ended September 30, 2004, the Company relied primarily on cash flows generated from operating activities to fund operations. At September 30, 2004, the Company had available $20.1 million of borrowing capacity under the Revolver, of which the Company can draw $16.1 million.

 

Operating activities utilized less than $0.1 million and provided $31.3 million of cash in the nine months ended September 30, 2004 and 2003, respectively, a decrease of  $31.3 million.  This decrease primarily resulted from a decrease in cash generated by changes in working capital assets and liabilities of $21.8 million and a net income decrease of $10.3 million from the prior-year period.

 

Investing activities used net cash of $2.2 million and $4.7 million in the nine months ended September 30, 2004 and 2003, respectively. The use of cash during the nine months ended September 30, 2003, consisted of purchases of property, plant and equipment.  The uses of cash for the nine months ended September 30, 2004, consisted of purchases of property, plant and equipment of $5.4 million, offset by cash received from the sale of the Company’s interest in Servibanca S.A. of $3.0 million.

 

Financing activities used $0.9 million and $3.7 million of net cash in the nine months ended September 30, 2004 and 2003, respectively.  Both uses of cash related primarily to the reduction of the Company’s debt.

 

At September 30, 2004, the Company’s principal outstanding debt instruments consisted of (i) no balance outstanding under the revolving credit facility maturing May 30, 2006 (which is more fully described below), (ii)  $94.0 million of 7.5% Senior Notes due 2008, and (iii) $103.8 million of Sponsor Notes due 2009. The Company or its affiliates may from time to time purchase, redeem or pay deferred interest on some of its outstanding debt or equity securities.  The Company would only make these payments in compliance with the covenants of its debt instruments.

 

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

 

Revolving Credit Facility. The Company has a revolving credit facility (the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which matures on May 30, 2006.  Effective May 7, 2003, the Company and Heller entered into an amendment to the Revolver which reduced the committed amount from $60 million to $40 million, while increasing the letter-of-credit sub-limit from $30 million to $40 million.  The Revolver is secured by substantially all the assets of the Company, subject to the limitations on liens contained in the Company’s Senior Notes.   Funds availability under the Revolver is determined by a borrowing-base formula equal to a specified percentage of the value of the Company’s eligible accounts receivable, inventory and pledged cash.  At September 30, 2004, the Company had no balance outstanding under the Revolver and an outstanding balance on letters-of-credit totaling $7.0 million.  The balance remaining under the Revolver that the Company can draw was $16.1 million at September 30, 2004 ($20.1 million in availability less a $4.0 million reserve).  A commitment fee of 0.5% per annum on the unused portion of the Revolver is payable quarterly.

 

The interest rate on loans under the Revolver is, at the Company’s option, either (1) 0.75% over prime or (2) 2.25% over LIBOR.  Under an amendment effective September 1, 2003, the interest rate margins over prime and LIBOR may be increased by 0.25% increments when the fixed charge coverage ratio falls below (1) 2.0 to 1.0, (2) 1.75 to 1.0, (3) 1.5 to 1.0 and (4) 1.25 to 1.0 and (total rate increase of 1.00%) or decreased by 0.25% increments when the fixed charge coverage ratio is greater than 2.25 to 1.0 (total rate decrease of 0.25%).  At September 30, 2004, the Company’s rate on the Revolver was 5.75%.

 

Under the Revolver, substantially all of the Company’s domestic cash receipts (including proceeds from accounts receivable and asset sales) must be applied to repay the outstanding loans, which may be re-borrowed subject to availability in accordance with the borrowing base formula. The Revolver contains restrictions on the use of cash for dividend payments or non-scheduled principal payments on certain indebtedness.  Restricted cash at September 30, 2004 of $7.0 million represents cash pledged under the terms of the Revolver.

 

The Revolver contains various representations, warranties and covenants, including financial covenants as to maximum capital expenditures, minimum fixed-charge coverage ratio and minimum average borrowing availability.  At September 30, 2004, the Company was in compliance with all covenants under the Revolver.

 

Senior Notes. In August 1998, the Company issued 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 mature on June 1, 2008.  The Senior Notes contain covenants placing limitations on the Company’s ability to permit subsidiaries to incur certain debts, incur certain loans, and engage in certain sale and leaseback transactions. During the six months ended June 30, 2003, the Company repurchased Senior Notes with a face amount of $3.9 million. The Company wrote off a proportionate share of deferred financing fees, resulting in a gain of approximately $1.1 million, which was reported as sundry (other) income in the condensed consolidated statements of operations for the six months ended June 30, 2003.

 

Unsecured Sponsor Note. The Company’s Sponsor Note bears interest at 10.0%, due and payable quarterly. The Sponsor Note is subordinate only upon bankruptcy or insolvency of the Company, or if upon maturity of the Senior Notes, the Senior Notes remain unpaid.  The payments began September 30, 1999. The Sponsor Note matures on July 22, 2009.  As provided under the agreement, however, the Sponsor Note holder, WCAS, elected to defer quarterly interest payments of $4.0 million for each of the September 2000 through September 2001 quarterly periods resulting in an increase in the principal amount of the Sponsor Note totaling $33.8 million.  Such election required a deferred financing fee of 30.0% of each of the interest payments being deferred.  The Company accounts for the additional financing fees as a change in the effective interest rate of the debt. WCAS may, at its election, defer each future quarterly payment under similar terms.  WCAS has not elected to defer 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 Sponsor Note.  A holder of Senior Notes had sought to contest this payment.  See discussion under Legal Proceedings.

 

Preferred Stock – Series A. The Company allocated the proceeds from its Series A preferred stock issuance based upon the relative fair value of the preferred stock and warrants issued. The related discount is being accreted over a period of 8 years. For the nine months ended September 30, 2004, accretion of the related discount and accrued but unpaid dividends totaled $1.4 million, increasing the carrying amount to $17.9 million. As of September 30, 2004, the stated value of the Series A preferred stock, including accumulated but unpaid dividends, was $197.83 per share.

 

Preferred Stock – Series B. For the nine months ended September 30, 2004, the Company accrued additional unpaid dividends for its Series B preferred stock totaling $2.1 million, increasing the carrying amount to $12.7 million.  As of September 30, 2004, the stated value of the Series B preferred stock, including accumulated but unpaid dividends, was $358.05 per share.

 

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See Note 3 – Reclassification, contained in Notes to the Condensed Consolidated Financial Statements, for a discussion of the reclassification of the Series A and B Preferred Stock to the permanent equity section of the Condensed Consolidated Balance Sheets under the guidance of EITF Topic D-98, “Classification and Measurement of Redeemable Securities.”

 

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

 

Contractual Obligations and Commercial Commitments.

In the normal course of business, the Company enters into various contractual and other commercial commitments that impact, or could impact, the liquidity of operations. The following table outlines the commitments at September 30, 2004:

 

		Total Amounts			Less than 1 Year			1-3 Years			4-5 Years			Over 5 Years
		(In Millions)
Long-term debt		$	197.8		$	—		$	—		$	197.8		$	—
Capital leases		0.8			0.6			0.2			—			—
Operating leases (non-cancelable)		15.3			5.1			6.2			2.8			1.2
Total Contractual		213.9			5.7			6.4			200.6			1.2
Unused lines of credit		$	20.1		$	20.1		$	—		$	—		$	—
Standby letters of credit		7.0			7.0			—			—			—
Total Commercial		$	27.1		$	27.1		$	—		$	—		$	—

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In June 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Accounting Standard (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of a nonpublic entity.  For mandatorily redeemable financial instruments of a nonpublic entity, this statement shall be effective for fiscal periods beginning after December 15, 2003.  The Company has adopted SFAS No. 150 with no effect on the Company’s results of operations or financial position.

 

FACTORS AFFECTING THE COMPANY’S BUSINESS AND PROSPECTS

 

Information provided by the Company in this Quarterly Report on Form 10-Q and other documents filed with the Securities and Exchange Commission include “forward-looking” information, as that term is defined in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). All statements other than statements of historical fact could be deemed forward-looking statements.  The Company cautions investors that actual results or business conditions may differ materially from those projected or suggested in such forward-looking statements as a result of numerous factors beyond the Company’s control. The Company undertakes no obligation to update or revise forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated results or changes to future operating results over time. The following is a description of some of the important factors that may cause the actual results of the Company’s operations in future periods to differ materially from those currently expected or desired.

 

General Economic Conditions

 

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

 

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

 

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