ITEM 1. BUSINESS.
Overview
BancTec, Inc. (BancTec or the Company), a Delaware corporation, is a worldwide provider of comprehensive enterprise content management, image capture devices, infrastructure support services and payment processing solutions. The Company helps customers create business efficiencies through innovative technology and services by combining advanced web-enabled imaging and workflow technologies with both BancTec-manufactured equipment and third-party equipment. These solutions are subsequently maintained and supported by the Company’s service operations. The Company is also a leading provider of personal computer maintenance services for major computer companies, government and corporate customers. Worldwide, the Company employs approximately 3,000 people full-time and is headquartered in Irving, Texas.
Founded in 1972, the Company operates worldwide serving approximately 2,000 customers in over 50 countries, with international revenue in 2004 representing approximately one-third of total revenues.
The Company markets its portfolio of solutions to specific target markets in which it believes it has extensive business process expertise and certain competitive advantages and is able to maintain or achieve a leadership position.
Ownership
In July 1999, BancTec entered into a recapitalization transaction. Welsh, Carson, Anderson & Stowe (“WCAS”), a private investment partnership, and Convergent Equity Partners, L.P. (“Convergent”), a private investment partnership, formed Colonial Acquisition Corp. (“Colonial”), with WCAS owning 93.5% and Convergent owning 6.5%. Through the merger of Colonial into BancTec, WCAS acquired 17,003,838 shares of BancTec’s common stock and Convergent acquired 1,181,946 shares of BancTec’s Class A common stock. In connection with the recapitalization, each previously outstanding share of BancTec common stock was converted into the right to receive $18.50 in cash, totaling approximately $360.2 million, and simultaneously canceled. Funding for the distribution to the former BancTec stockholders was provided by a $145.0 million capital contribution from WCAS and Convergent, by the Tranche A Term Loan, the Sponsor Note, and the Revolving Credit Facility. In addition to the funds that were paid for the shares, cash payments were made for employee stock options of $9.3 million and an employee stock purchase plan of $0.3 million. The options and the employee stock purchase plan payments were recorded as a reduction to stockholders’ equity. In subsequent transactions occurring in 2000 and 2001, Series A preferred stock (“Series A Preferred”) which included warrants and Series B preferred stock (“Series B Preferred”) which included conversion rights were issued to WCAS.
In 2002, the Company and the owners of all the outstanding capital stock of the Company consummated a series of transactions in order to create a two-tier holding company structure above the Company. As a consequence of the restructuring, all the outstanding capital stock of the Company and warrants to purchase capital stock of the Company (but not employee stock options) are held by BancTec Intermediate Holding, Inc., a Delaware corporation (“Intermediate Holding”). In turn, all the outstanding capital stock of Intermediate Holding is held by BancTec Upper-Tier Holding, LLC, a Delaware limited liability company (“Upper-Tier Holding”), whose members consist of the prior owners of all the outstanding capital stock of the Company. As part of the restructuring, WCAS Capital Partners III, L.P. contributed to Upper-Tier Holding the Senior Subordinated Note Due 2009 originally issued to it by the Company, together with pay-in-kind interest thereon, in an aggregate principal amount of approximately $193.8 million (the “Sponsor Note”). In addition, Intermediate Holding contributed $100,000 to the Company in exchange for 667 shares of Series A Preferred Stock of the Company.
WCAS is one of the largest private equity investment firms in the U.S. focused exclusively on investments in three industries: information and business services, healthcare, and communications. Since its founding in 1979, WCAS has organized 13 limited partnerships with total capital of more than $12 billion. The firm currently invests out of Welsh, Carson, Anderson & Stowe IX, L.P., a $3.8 billion equity fund, and WCAS Capital Partners IV, L.P., a $1.3 billion dedicated subordinated debt fund.
Products and Markets
Worldwide Solutions. The worldwide solutions group is made up of U.S. Solutions (“USS”) and International Solutions (“INTL”). These two operations offer similar systems integration and business process solutions and services, and market to similar types of customers. The solutions offered primarily involve high-volume transaction processing using advanced technologies that capture, process and archive paper and electronic documents. The Company’s powerful, high-volume integrated systems deliver important benefits to some of the world’s largest credit card companies and major banks. In
addition, these segments provide their products and services to other customers, including financial services companies and insurance providers, telecommunications companies, utility companies, governmental agencies, and retail companies.
The Company combines its extensive business application knowledge with a full range of software and equipment offerings for complex transaction processing environments. The Company’s integrated systems generally incorporate advanced applications software developed by the Company and by third parties. These solutions may also include hardware developed and manufactured by the Company as well as by third parties. Key applications provided by USS and INTL focus around the following process services and solutions:
Enterprise Content Management (“ECM”). The Company’s ECM business offers complete solutions to capture, process, and archive information. The Company’s software products, marketed under the eFIRST brand, are highly scaleable, designed for high-volume, complex and distributed environments. eFIRST Capture provides a software solution to capture structured or unstructured documents from paper scanners, fax machines and e-mail and then extract key information needed to categorize, index and distribute the data to the appropriate person or department. eFIRST Process is a Business Process Management tool that enables business process automation through analysis, modeling, development and deployment. eFIRST Process provides intelligent workflow and routing of documents and cases in complex environments based on business rules. eFIRST Archive can store large volumes of highly complex documents and provide multiple indices for improved search and retrieval. These software products can be implemented on a stand-alone basis or incorporated with the Company’s hardware.
The DocuScan 9000, introduced in 2004, is a high-speed mixed document scanner designed to provide the highest hourly throughput in difficult paper handling applications. The S-Series is a color page scanner optimized for forms processing environments with standard or similar size documents.
Image Capture. The Company provides a complete line of products and services to address the high-volume check or mixed document imaging environment. In addition to the DocuScan 9000 and S-Series, the company offers the E-Series and X-Series transports. The E-Series is a high-speed transport that can read and sort between 10,000 and 1,000,000 check-size documents per day. The X-Series offers a mid-range transport for check and remittance processing which enables check and item-based transactions to be digitally captured, processed and retained. To help companies achieve optimal performance in day-to-day check imaging operations, the Company offers its advanced image quality software, Image Sentry.
Payment Processing. The Company is focused on helping customers move into the new era of remittance processing by addressing current issues around check conversion with ACH, ARC and check truncation with Check 21. The passage of the Check Clearing for the 21st Century Act (“Check 21”), which facilitates check truncation by authorizing substitute checks, is expected to result in decreased demand for payment and check clearing solutions. The Company’s suite of payments processing solutions take advantage of new technology advances, such as automatic image recognition and internet accessibility, to offset labor costs, facilitate timely research and handle complex transaction variations. The payment processing suite includes eCap, a data capture application that automates check and list processing and the extraction of data from invoices or payment advices. PayCourier Retail is a comprehensive remittance solution for processing payment transactions, such as return documents, customer correspondences, customer envelopes and checks. PayCourier Archive is a transaction archive solution that provides long-term data and image storage for remittance processing.
Support and Managed Services. The Company provides customers with worldwide system support for hardware and software products. The Company provides expertise in the installation, repair and maintenance of large mission critical computer driven electromechanical devices, such as reader/sorters and scanners, which involve imaging and paper handling. The Company employs customer service engineers located in the United States and international locations to perform such service. The Company’s maintenance contracts usually include both parts and labor, and the contracts are typically renewed for five to seven years. In addition, the Company markets a full range of consumable supplies that complement the Company’s document processing systems.
Managed Services involves handling large volumes of mixed daily correspondence and transactions using advanced image, workflow, and document technologies. The Company focuses on streamlining specific business critical processes to reduce costs, while maintaining consistently high standards and improving customer services. The Company works closely with customers to highlight areas where further efficiencies can be achieved. Value-added solutions, using advanced technology, deliver process improvements in a structured and innovative way. The Company has offered and sold outsourcing services for document management processes and payment processes in Europe, and plans to expand the offering of these services to customers in the United States in 2005.
Computer and Network Services (“CNS”). CNS provides quality integrated support services to the evolving Information Technology industry, with focused deployment and ongoing support solutions for the original equipment manufacturer (“OEM”), Enterprise and Fortune marketplaces. CNS provides coverage in North America and Europe with OEM partners in providing warranty and fulfillment services and related support to manufacturers of desktop/enterprise products. In addition, CNS enters into strategic alliances with industry recognized providers of outsourcing services and system integrators, as well as individual corporate customers. These customers include defense and aerospace companies, strategic outsourcing organizations, and consumer electronics manufacturers.
Information About Industry Segments
Operating segments are defined as components of a company about which separate financial information is available that is evaluated regularly by the company’s chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. In 2002 through 2004, the Company reported its operations as three primary segments, US Solutions (“USS”), International Solutions (“INTL”), and CNS. The operations of USS and INTL include manufacturing and supplies, maintenance of Company-manufactured and related products, integrated systems, and BancTec software products sold through Plexus Software (“Plexus”), a division of BancTec. The CNS operations include personal computer repair services and administration of third-party extended-service contracts. INTL reporting includes both US and International operations of Plexus.
On November 27, 2002, the Company sold its operations in Japan. As a result, all segment reporting has been restated to reflect the Japanese operations as discontinued operations. The details of this disposition are discussed in Notes to the Consolidated Financial Statements.
Note L - Business Segment Data and Note M - Geographic Operations, contained in Notes to the Consolidated Financial Statements, include detailed financial information concerning the Company’s segments and geographic areas.
Geographical Locations
There are no significant risks associated with foreign operations other than the fluctuation of international currencies (in Europe), political environments and economic cycles. Note L - Geographic Operations, contained in Notes to the Consolidated Financial Statements, includes detailed financial information concerning the Company’s geographic operations.
Product Development
The Company is engaged in ongoing software and hardware product development activities for both new and existing products, employing approximately 105 people for such activities as of December 31, 2004.
The following table sets forth the Company’s product development expenses:
Current expenditures are concentrated on developing new applications for the Company’s product lines and improving and expanding existing products. The Company is currently focusing on Enterprise Content Management (“ECM”) solutions and image capture solutions. There can be no assurance that the Company’s development efforts will result in successful commercial products. Many risks exist in developing new product concepts, adapting new technology and introducing new products to the market.
Enterprise Content Management. BancTec’s ECM business is organized around a set of high-level reusable components that form the basis of vertical solutions for specific markets. The three core modules in the eFIRST™ suite of solutions, generic capture system (eFIRST Capture), business process automation (eFIRST Process), and archiving (eFIRST Archive), can be integrated within the same environment and expanded. In addition, the Company will add key managed services capabilities to these products.
eFIRST Capture captures, sorts and processes data from many types of documents, such as e-mail, web, scanned documents, faxes and web-forms, and provides real-time access to this data for subsequent use.
eFIRST Process provides a technology platform and user tools to construct workflows, data views, user environments and access permission models that draw in existing systems and people to automate business processes.
eFIRST Archive addresses the secure, structured storage and future retrieval of data.
Image Capture. In 2005, the Company plans to continue developing options for the DocuScan 9000 system and make strategic market-based investments in the E-Series and X-Series transports. All other products are now effectively in a sustaining mode only of development.
Sales and Distribution
The Company primarily relies on its internal sales force. BancTec’s distribution strategy is to employ multiple delivery channels to achieve the widest possible distribution. The Company’s products are sold to end-users, distributors, OEMs, value-added resellers and systems integrators.
International sales are subject to various risks, including fluctuations in exchange rates, import controls and the need for export licenses.
Customer Diversification
For the years ended December 31, 2004, 2003 and 2002, Dell, accounted for 17.4%, 15.7%, and 16.2%, respectively, of the total revenue of the Company (as restated for discontinued operations). The Company’s ten largest customers accounted for 44.3%, 42.7%, and 39.6%, of the Company’s revenues (as restated for discontinued operations) for the years ended December 31, 2004, 2003, and 2002 respectively.
Competition
In marketing its products and services, the Company encounters aggressive competition from a wide variety of companies, some of which have substantially greater resources than BancTec. The Company believes that functionality, performance, quality, service and price are important competitive factors in the markets in which it operates. Generally, the Company emphasizes industry knowledge, unique product features, flexibility, quality and service to configure unique systems from standard components in its competitive efforts. While the Company believes that its offerings compete favorably based on each of these elements, the Company could be adversely affected if its competitors introduce innovative or technologically superior solutions or offer their products at significantly lower prices than the Company. No assurance can be given that the Company will have the resources, marketing and service capability, or technological knowledge to continue to compete successfully.
Backlog
The Company believes that backlog is not a meaningful indicator in understanding BancTec’s business nor a meaningful indicator of future business prospects due to the large volume of products delivered from shelf inventories and the relative portion of net revenue related to the Company’s services businesses. In addition, any backlog information would exclude CNS contracts, recurring hardware and software maintenance contracts, and contracts for sales of supplies. Further, the Company’s backlog is subject to fluctuation due to various factors, including the size and timing of orders for the Company’s products and exchange rate fluctuations, and accordingly, is not necessarily indicative of the level of future revenue.
Manufacturing - Suppliers
The Company’s hardware and systems solutions are assembled using various purchased components such as PC monitors, minicomputers, encoders, communications equipment and other electronic devices. Certain products are purchased from sole source suppliers. The Company generally has contracts with these suppliers that are renewed periodically. The Company has not experienced, nor does it foresee, any significant difficulty in obtaining necessary components or subassemblies; however, if the supply of certain components or subassemblies was interrupted without sufficient notice, the result could be an interruption of product deliveries.
Patents
The Company owns numerous U.S. and foreign patents and holds licenses under numerous patents owned by others. The Company also owns a number of registered and common-law trademarks in the U.S. and other countries relating to the Company’s trade names and product names.
The validity of any patents issued, or that may be issued, to the Company may be challenged by others and the Company could encounter legal difficulties in enforcing its patent rights against infringement. In addition, there can be no assurance that other technology cannot or will not be developed, or that patents will not be obtained by others, that would render the Company’s patents obsolete.
Employees
At December 31, 2004, the Company employed approximately 3,000 full-time employees. None of the Company’s employees is represented by a labor union. The Company has never experienced a work stoppage.
ITEM 2.
ITEM 2. PROPERTIES.
The principal executive offices of the Company are located in its Irving, Texas facility.
The Company consolidated additional personnel at its Irving, Texas facility in January 2002, vacating substantially all (90%) of an owned facility in Dallas, Texas. The Company recorded an impairment charge of $1.5 million during the fourth quarter of 2001 and the facility is currently being offered for sale. In addition, during February 2005, the Company consolidated personnel from another owned facility in Dallas, Texas to its facility in Irving, Texas. This facility is also being offered for sale.
As of December 31, 2004, the Company owned or leased numerous facilities throughout the world to support its operations. The Company believes that these facilities are adequate to meet its ongoing needs. The loss of any of the Company’s principal facilities could have an adverse impact on operations in the short term. The Company has the option to renew its facility leases or believes it can replace them with alternate facilities at comparable cost. The Irving manufacturing facility, which the Company owns, is the primary location for the Company’s administration, assembly and manufacturing activities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
A lawsuit captioned Cerberus International, Ltd., et al. vs. BancTec, Inc., et al. (Case No. 03600287) was filed on January 28, 2003 in the Supreme Court of the State of New York for the County of New York naming as defendants the Company and certain of its affiliates. The complaint alleges that the Company improperly made a payment to the holder of the Sponsor Note and sought damages of not less than $89 million as a result of the alleged improper payment and the imposition of a constructive trust on monies paid by the Company to the holder of the Sponsor Note. The Company’s $90 million payment to the holder of the Sponsor Note was disclosed in the Company’s Current Report on Form 8-K dated November 27, 2002.
On May 5, 2004, the Supreme Court granted the Company’s motion for summary judgment dismissing the plaintiffs’ complaint in its entirety. On or about November 8, 2004, the plaintiffs/appellants filed their brief with the appellate division of the New York Supreme Court. On March 3, 2005, the Supreme Court of New York, Appellate Division affirmed the lower court’s decision in favor of BancTec.
The Company is a party to various other legal proceedings. None of those current proceedings is expected to have an outcome that is material to the financial condition or operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table presents selected consolidated historical financial data for the periods indicated. The selected historical consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company for the three years ended December 31, 2004, 2003 and 2002, and the related notes thereto.
In November 2002, the Company completed the sale of BancTec Japan. For financial statement purposes, the sale was treated as a discontinued operation. As a result, the financial data above has been restated for 2002 and prior years to reflect the continuing operations of the Company.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THAT APPEAR ELSEWHERE IN THIS DOCUMENT.
The following discussion contains forward-looking statements as that term is defined in the PSLRA. See “Forward Looking Statements.” The Company cautions investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including those described below under the caption “Factors Affecting the Company’s Business and Prospects.” 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.
Highlights
The Company believes several factors continued to create a challenging and competitive sales and cost-containment environment during the year ended December 31, 2004. These factors include: general economic conditions and 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 2004, the USS and INTL segments experienced revenue declines in the maintenance business, the duration of which the Company cannot predict.
Expected economic and business conditions into 2005 indicate a cautious outlook regarding the Company’s near-term revenue and earnings growth prospects. Many of the Company’s product offerings represent a significant capital expenditure for its customers. General economic conditions and the impact of check truncation have caused a continued weakening in demand for payment and check solutions products offered in North America. The Company continues to introduce new product offerings in its Enterprise Content Management (“ECM”) solutions as well as expand its managed services business into North America. In addition, the Company continues to seek reductions in operating costs. Product-development efforts are focused on ECM solutions as well as 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.
Critical Accounting Policies
The Company’s significant accounting policies and methods used in the preparation of the Consolidated Financial Statements are discussed in Note A of the Notes to Consolidated Financial Statements. The following is a listing of the Company’s critical accounting policies and a brief discussion of each:
• Revenue recognition
• Allowance for doubtful accounts
• Inventory valuation
• Goodwill
• Income taxes
• Stock-based compensation
Revenue Recognition. The Company derives revenue primarily from two sources: (1) product sales - systems integration solutions 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 - 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 initial 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 invoiced. 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 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, and 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 as services are performed over time or on a “per call” basis.
Allowance for Doubtful Accounts. The Company’s allowance for doubtful accounts relates to trade accounts receivable. The allowance for doubtful accounts is an estimate prepared by management based on identification 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. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Likewise, should the Company determine that it would be able to realize more of its receivables in the future than previously estimated, an adjustment to the allowance would increase income in the period such determination was made. The allowance for doubtful accounts is reviewed periodically and adjustments are recorded as deemed necessary.
Inventory Valuation. The Company periodically 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 inventory turnover 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, additional write-downs may be required. The inventory write-down calculations are reviewed periodically and additional write-downs are recorded as deemed necessary.
Goodwill. Since January 1, 2002, when Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” became effective, the Company has assessed the impairment of goodwill annually, or more frequently whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company assesses the recoverability of the goodwill by comparing the fair value of the intangible asset to the carrying amount. Any impairment is measured based on a projected discounted cash flow method using a discount rate reflecting the Company’s average cost of funds. Goodwill amounted to approximately $41.5 million as of December 31, 2002. Prior to January 1, 2002, the Company amortized its goodwill. As required by SFAS No. 142, the Company performed an initial impairment review of goodwill in 2002 as a transition to the current method. As a result of that review, during 2002, the Company recorded as a cumulative 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 the carrying value of goodwill.
Income Taxes. The Company is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating the Company’s actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which would be included within the Company’s consolidated balance sheet. The Company must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent that the Company believes recovery is not likely, the Company must establish a valuation allowance. To the extent the Company establishes a valuation allowance in a period, the Company must include an expense within the tax provision in the statement of operations. The Company has recorded a valuation allowance to reduce the carrying amount of recorded deferred tax assets representing future deductions to an amount that is more likely than not to be realizable. In the event the Company were to determine that it would be able to realize additional deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the period such determination was made.
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.
DISCONTINUED OPERATIONS
On November 27, 2002, the Company completed the sale of its wholly-owned subsidiary, BancTec Japan (“BTJ”), to JAFCO MBO Co., Ltd. (“JAFCO”) pursuant to a Stock Purchase Agreement dated as of November 27, 2002, between the
Company and JAFCO. The sale involved two separate transactions: (1) the purchase by JAFCO of 100% of the outstanding shares of BTJ for 6.5 billion yen, and (2) a one-time, up-front payment by BTJ to the Company of 4.0 billion yen under certain distribution and licensing agreements. Under such agreements, BTJ will continue to supply the Company products and services in its markets, and will continue to operate under the name “BancTec Japan.” After foreign-currency conversions and transaction costs, the Company received approximately US $82.5 million in aggregate net proceeds and recorded a pre-tax gain of approximately $63.0 million. For financial statement purposes, the Company treated the sale as a discontinued operation, and accordingly, financial statement presentation was made in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
RESULTS OF OPERATIONS
The operating results of BancTec Japan have been treated as a discontinued operation in the accompanying financial statements.
Comparison of Years Ended December 31, 2004 and December 31,
Consolidated revenue of $360.7 million for the year ended December 31, 2004 decreased by $18.2 million or 4.8% from the comparable prior-year period. The USS revenue decrease of $28.1 million was partially related to the decline in maintenance revenue due to the Company’s installed products reaching the end of their useful lives and from increasing competition. The Company expects these trends to continue on these end of life products. 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. The CNS decrease of $1.1 million resulted from pricing decreases, domestic competitive pressure, and decreased volumes under certain maintenance programs, partially offset by revenue increases resulting from the expansion by CNS of operations into Europe. Increases in INTL of $13.5 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 managed services as well as increased sales in Europe of ECM solutions. Factors expected to impact future revenue include corporate-customer spending for large systems-solutions, the continued impacts of check truncation, industry consolidation reducing the volume of customers, on-going competitive pressures, and fluctuations in international currencies.
Consolidated gross profit of $80.4 million decreased by $10.3 million or 11.4% from the comparable prior-year period. Decreases in CNS of $7.7 million and USS of $6.4 million were partially offset by increases in INTL of $4.7 million. The decrease in USS resulted from decreased revenues as well as a decrease in the USS gross margin percentage from 22.7% to 22.6%. Increases in INTL gross profit resulted partially from increased revenue, including the impact of currency conversion, as well as a higher gross profit percentage, increasing from 32.9% to 33.1%. Continued efforts to provide proven deliverables as well as targeted new offerings, including ECM solutions, image capture solutions and hardware enhancements, which, along with ongoing cost-containment efforts, contributed to the strengthening of INTL gross profit. CNS’ gross profit percentage decreased from 15.1% to 9.1% resulting primarily from decreased revenue, margin reduction caused by competition pricing pressure and volume 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 $64.6 million represented a decrease of $2.2 million compared to the comparable prior-year period. Operating expenses, by component, changed as follows: (1) Product development expenses decreased $4.7 million compared to the prior year primarily due to the focused realignment of research and development expenditures against future product strategies and marketing plans. (2) Selling, general, and administrative expenses increased by $2.5 million or 4.6%. The increase partially resulted from additional marketing expenditures aimed at new product strategies, increased IT-related expenditures and severance obligations to former officers of the Company.
Interest expense for the year ended December 31, 2004 decreased to $19.1 million from $19.5 million in the comparable prior-year period.
Sundry items resulted in a net loss of $1.0 million during the year ended December 31, 2004 as compared to net income of $1.4 million during the comparable prior-year period. This decrease is primarily due to 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 of approximately $1.1 million from the Company’s repurchase of Senior Notes during the prior-year period.
An income tax provision of $13.6 million for the year ended December 31, 2004, is compared to a corresponding prior-year income tax benefit of $11.4 million. The Company’s effective income tax rate was approximately (377.7%) as compared to (176.1%) for the corresponding prior-year period. During 2004, the Company recorded an additional valuation allowance of
$10.5 million on the deferred income tax asset to reduce that asset to a carrying amount that is more likely than not to be realizable.
Comparison of Years Ended December 31, 2003 and December 31, 2002
Consolidated revenue of $378.9 million for the year ended December 31, 2003 decreased by $0.5 million or 0.1% from the comparable prior-year period. The CNS decrease of $8.8 million is primarily due to pricing decreases resulting from competitive pressure, as well as decreased volumes under certain maintenance programs. The USS decrease of $6.8 million was principally related to a 13.3% 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.
Declines in maintenance revenues were somewhat offset by a 12.5% increase in revenues related to the sale and installation of hardware and software products. The INTL increase of $15.1 million primarily relates to the introduction in the United Kingdom of document processing services during 2003 and the impact of the weakening dollar on the conversion of revenue stated in foreign currencies. Factors impacting future revenue include lower corporate-customer spending for large systems solutions as a result of economic weakness, customer and prospective customer mergers, on-going competitive pressures, fluctuations in international currencies, and the impact of the reduction of volumes in check processing.
Consolidated gross profit of $90.7 million decreased by $5.5 million or 5.7% from the comparable prior-year period. The decrease in CNS of $14.4 million was partially offset by increases in USS of $0.5 million and INTL of $8.4 million. CNS’ gross profit decrease was primarily attributable to decreased revenue as well as margin pressure caused by pricing pressures, increased competition, increased labor costs, and a change in revenue mix. The INTL increase resulted from increased revenues and improvements in the gross profit percentage resulting from cost containment efforts. USS gross profit increased despite decreased revenues due to lower cost of sales resulting from the Company’s cost-containment efforts and changes in the Company’s revenue mix. The Company is in the process of transitioning its product-offering focus to proven deliverables and new targeted offerings, including EDM solutions, its other archive solutions and hardware enhancements. Incorporating more third-party products into the Company’s solutions rather than developing the products has enabled the concentration of efforts and expenditures on the targeted items which, along with the Company’s ongoing cost-containment efforts, allowed for cost reductions to help offset revenue declines.
Operating expenses of $66.8 million represented a decrease of $4.2 million compared to the comparable prior-year period. Operating expenses, by component, changed as follows: (1) Product development expenses decreased $3.5 million compared to the prior year primarily due to the focused realignment of research and development expenditures against future product strategies and marketing plans and due to the use of outsourced product-development. (2) Selling, general, and administrative expenses decreased by $0.7 million due primarily to on-going efforts to realign the cost structure.
Interest expense for the year ended December 31, 2003 decreased to $19.5 million from $33.1 million in the comparable prior-year period. The decrease was due mainly to the payment of $90.0 million on the Sponsor Note in December 2002 and the repurchase of a portion of the Senior Notes.
Sundry items resulted in a net income of $1.4 million during the year ended December 31, 2003 as compared to net income of $8.3 million during the comparable prior-year period. This decrease is primarily due to foreign exchange gains of $0.2 million and a gain of approximately $1.1 million from the Company’s repurchase of Senior Notes during the current year period, compared to foreign exchange gains of $1.4 million and a gain of $6.8 million as a result of the repurchase of Senior Notes during 2002.
The net tax benefit of $11.4 million for the year ended December 31, 2003, resulted from $2.4 million of income tax expense attributable to current results, net of $13.8 million of income tax benefit related to the release of valuation allowance compared to a corresponding prior-year period income tax provision of $0.3 million. The Company’s effective tax rate was approximately (176.1%) for the year ended December 31, 2003 as compared to 5.1% for the corresponding prior-year period.
On November 27, 2002, the Company completed the sale of its wholly-owned subsidiary, BancTec Japan (“BTJ”). After foreign-currency conversions and transaction costs, the Company received approximately US $82.5 million in aggregate net proceeds. For financial statement purposes, the Company treated the sale as a discontinued operation and its operating results have been segregated and reported as discontinued operations. The Company recorded a gain on the disposal of the business of $63.0 million (net of income tax expense of $0). Income from the discontinued operations of BTJ for the year ended December 31, 2002 was $2.7 million.
The Company adopted SFAS No. 142 as of January 1, 2002. SFAS 142 required the Company to perform an initial review of impairment of goodwill in 2002. As a result of that review, during 2002, the Company recorded as a cumulative 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 the carrying value of goodwill.
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, decreased revenues from the Company’s maintenance contracts, and the requirement to obtain performance bonds or similar instruments could have a material impact on the Company’s future liquidity.
The Company’s cash and cash equivalents totaled $51.5 million at December 31, 2004, compared to $61.6 million at December 31, 2003. Working capital decreased $0.8 million to working capital of $11.5 million at December 31, 2004. The change in working capital included decreases in deferred revenue, current maintenance contract deposits and customer advances totaling $2.8 million, a decrease in other accrued liabilities of $1.6 million, an increase in accounts payable of $1.4 million and an increase in accrued income taxes of $1.4 million. Current assets decreases of $2.7 million included the decrease in cash of $10.1 million, partially offset by an increase in accounts receivable of $6.5 million and a decrease in current deferred tax assets of $0.4 million.
During 2004, the Company relied primarily on cash reserves to fund operations. At December 31, 2004, the Company’s remaining availability under the Revolver, as hereinafter defined, was $20.7 million, of which the Company could draw $16.7 million.
Operating activities utilized $5.7 million of cash in 2004 and provided $39.6 million of cash in 2003, a decrease of $45.3 million. This decrease primarily resulted from a decrease in cash generated by changes in working capital assets and liabilities of $32.2 million and a decrease in net income of $32.2 million.
Investing activities used net cash of $3.5 million during 2004 compared to $6.3 million in 2003. The uses of cash for 2003 consisted of purchases of property, plant and equipment. The uses of cash for 2004 consisted of purchases of property, plant and equipment of $6.8 million, offset by cash received from the sale of the Company’s interest in Servibanca S.A. of $3.0 million.
Financing activities used $1.2 million of net cash in 2004 compared to $3.9 million of net cash in 2003. Both uses of cash consisted primarily of reductions to the Company’s debt.
At December 31, 2004, the Company’s principal outstanding debt instruments consisted of (i) $0.001 million 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 Sponsor Notes due 2009. As of December 31, 2004, the Company’s foreign subsidiaries had no outstanding borrowings. 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.
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 assets sales may generate.
Revolving Credit Facility. The Company has a revolving credit facility (the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which will mature on May 30, 2006. Effective May 7, 2003, the Company and Heller entered into an amendment to the Revolver which 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 December 31, 2004, the Company had $0.001 million outstanding under the Revolver and an outstanding balance on letters-of-credit totaling $4.0 million. The availability remaining under
the Revolver that the Company can draw was $16.7 million at December 31, 2004 ($20.7 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) 1.25% over prime or (2) 2.75% over LIBOR. Under an amendment effective September 1, 2003, the interest rate margins over prime and LIBOR may be increased by 0.25% increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0 and (2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by 0.25% increments when the fixed charge coverage ratio is greater than (1) 1.75 to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of 0.75%). The interest rate was re-measured as of the effective date of September 1, 2003 under this amendment. At December 31, 2004, the Company’s weighted average rate on the Revolver was 6.50% under the prime option.
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 December 31, 2004 of $4.1 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. Effective December 31, 2004, the Company and Heller amended the loan and security agreement to decrease the minimum fixed charge coverage ratio at December 31, 2004 from 1.1 to 1.0. The Company has experienced recent decreases in its fixed charge coverage ratio which has necessitated amendments to the Revolver agreement with Heller. It is anticipated that future amendments may be necessary should the fixed charge coverage ratio continue to decline. At December 31, 2004, the Company was in compliance with all covenants under the Revolver.
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 placing limitations on the Company’s ability to permit subsidiaries to incur certain debts, incur certain loans and liens, and engage in certain sale and leaseback transactions. During the year ended December 31, 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 2003.
Senior Subordinated Unsecured Sponsor Note. The Company’s $160.0 million 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 June 2000 through September 2001 quarterly periods resulting in an increase in 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 elected not to defer the quarterly payments since September 2001 and currently does not intend to elect deferral of the quarterly payments in the near future. In accordance with the terms of the Sponsor Note, on December 6, 2002, the Company made a $90 million principal payment on the Sponsor Note. A holder of the Senior Notes had sought to contest this payment. See discussion under Item 3, Legal Proceedings. The Company wrote off a proportionate share of deferred financing fees totaling $3.8 million in 2002.
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 was being accreted over a period of 8 years though March 31, 2004, when the agreement was amended to remove the mandatory redemption provision. For the year ended December 31, 2004, accretion of the related discount and accrued but unpaid dividends totaled $1.4 million, increased the carrying amount to $18.0 million. As of December 31, 2004, the stated value of the Series A preferred stock, including accumulated but unpaid dividends, was $201.32 per share.
Preferred Stock - Series B. For the year ended December 31, 2004, the Company accrued additional unpaid dividends for its Series B preferred stock totaling $2.9 million, increasing the carrying amount to $13.5 million. As of December 31, 2004, the stated value of the Series B preferred stock, including accumulated but unpaid dividends, was $380.63 per share.
See Note A - Summary of Significant Accounting Policies, under Reclassification, contained in Notes to the Consolidated Financial Statements, for a discussion of the reclassification of the Series B Preferred Stock out of permanent equity to the mezzanine section of the 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.
Off Balance Sheet Arrangements
The Company currently does not have any off balance sheet arrangements.
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 December 31, 2004:
Purchase Obligations - Purchase obligations are defined as contractual obligations to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. Purchase obligations do not include contracts that may be cancelled without penalty.
NEW ACCOUNTING PRONOUNCEMENTS
On December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair-value-based method. The Company is required to adopt SFAS No. 123(R) in the third quarter of fiscal 2005, beginning July 1, 2005. The Company is currently assessing the final impact of this standard on the company’s consolidated results of operations, financial position, and cash flows. This assessment includes evaluating option valuation methodologies and assumptions as well as potential changes to the Company’s compensation strategies.
In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which will become effective for the Company beginning January 1, 2006. This standard clarifies that abnormal amounts of idle facility expense, freight, handling costs and wasted material should be expensed as incurred and not included in overhead. In addition, this standard requires that the allocation of fixed production overhead costs to inventory be based on the normal capacity of the production facilities. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations, but does not believe the impact of the change will be material.
On October 22, 2004, a new tax law was passed, the American Jobs Creation Act of 2004 (the “Jobs Creation Act”), which raised a number of issues with respect to accounting for income taxes. In response, on December 21, 2004, the FASB issued two FASB Staff Positions (FSP), FSP 109-1 - “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” and FSP 109-2 - “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” which became effective for the Company upon issuance.
The Jobs Creation Act provides a deduction for income from qualified domestic production activities, to be phased in from 2005 through 2010, which is intended to replace the existing extra-territorial income exclusion for foreign sales. In FSP 109-1, the FASB decided the deduction for qualified domestic production activities should be accounted for as a special deduction under SFAS No. 109, rather than as a rate reduction. Accordingly, any benefit from the deduction will be reported in the period in which the deduction is claimed on the tax return and no adjustment to deferred taxes at December 31, 2004, is required.
The Jobs Creation Act also creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and uncertainty remains as to how to interpret numerous provisions in the Act. FSP 109-2 addresses when to reflect in the financial statements the effects of the one-time tax benefit on the repatriation of foreign earnings. Under SFAS No. 109, companies are normally required to reflect the effect of new tax law changes in the period of enactment. FSP 109-2 provides companies additional time to determine the amount of earnings, if any, that they intend to repatriate under the Jobs Creation Act’s provisions. (See Note H, contained in Notes to the Consolidated Financial Statements, for more discussion of the impact of the Jobs Creation Act, including the Company’s status on the repatriation of foreign earnings.)
FACTORS AFFECTING THE COMPANY’S BUSINESS AND PROSPECTS
Information provided by the Company in this Annual Report on Form 10-K 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.
Technological Changes and Product Transitions
The Company’s industry is characterized by continuing improvement in technology, which results in the frequent introduction of new products, short product life cycles and continual improvement in product price/performance characteristics. The Company must incorporate these new technologies into its products and solutions in order to remain competitive. There can be no assurance that the Company will be able to continue to manage technological transitions. A failure on the part of the Company to effectively manage these transitions of its product lines to new technologies on a timely basis could have a material adverse effect on the Company. In addition, the Company’s business depends on technology trends in its customers’ businesses. Many of the Company’s traditional products depend on the efficient handling of paper-based transactions. To the extent that technological changes impact the future volume of paper transactions, the Company’s traditional business may be adversely impacted.
Dependence on Suppliers
The Company’s hardware products depend on the quality of components that are procured from third-party suppliers. Reliance on suppliers, as well as industry supply conditions, generally involves several risks, including the possibility of defective parts (which can adversely affect the reliability and reputation of the Company’s products), a shortage of components and reduced control over delivery schedules (which can adversely affect the Company’s manufacturing efficiencies) and increases in component costs (which can adversely affect the Company’s profitability).
The Company has several single-sourced supplier relationships, either because alternative sources are not available or the relationship is advantageous due to performance, quality, support, delivery, capacity or price considerations. If these sources are unable to provide timely and reliable supply, the Company could experience manufacturing interruptions, delays or inefficiencies, adversely affecting its results of operations. Even where alternative sources of supply are available, qualification of the alternative suppliers and establishment of reliable supplies could result in delays and a possible loss of sales, which could affect operating results adversely.
Indebtedness and Impact on Operating Results
As a result of the Company’s high debt to equity ratio, the Company is required to devote significant cash to debt service. This limits the Company’s future operating flexibility and could make the Company more vulnerable to a downturn in its operating performance or a decline in general economic conditions. The Company has experienced recent decreases in its fixed charge coverage ratio which has necessitated amendments to the Revolver agreement with Heller. It is anticipated that future amendments may be necessary should the fixed charge coverage ratio continue to decline.
International Activities
The Company’s international operations are a significant part of the Company’s business. The success and profitability of international operations are subject to numerous risks and uncertainties, such as economic and labor conditions, political instability, tax laws (including U.S. taxes on foreign subsidiaries) and changes in the value of the U.S. dollar versus the local currency in which products are sold. Any unfavorable change in one or more 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 and will depend on numerous factors, including the following: customer demand and market acceptance 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 the spending patterns of its customers, which in turn are subject to prevailing economic conditions
and other factors beyond the Company’s control. In addition, recent laws governing check truncation could reduce the demand for the Company’s payment products. Any unfavorable change in one or more of these factors could have a material adverse effect on the Company.
Product Development Activities
The strength of the Company’s overall business depends in part on the Company’s ability to develop products and solutions based on new or evolving technology and the market’s acceptance of those products. There can be no assurance that the Company’s product development activities will be successful, that new technologies will be available to the Company, that the Company will be able to deliver commercial quantities of new products in a timely manner, that those products will adhere to generally accepted industry standards or that products will achieve market acceptance. Many of the Company’s customers use its products in highly regulated or technologically demanding industries. As a result of products introduced by the Company’s competitors, generally accepted industry standards can change rapidly in ways that are beyond the control of the Company.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company is subject to certain market risks arising from transactions in the normal course of its business, and from obligations under its debt instruments. Such risk is principally associated with interest rate and foreign exchange fluctuations, as explained below.
Interest Rate Risk
The Company utilizes long-term fixed rate and short-term variable rate borrowings to finance the working capital and capital requirements of the business. At December 31, 2004 and 2003, the Company had outstanding Senior Notes, due in 2008, of $94.0 million, with a fixed interest rate of 7.5%. At December 31, 2004 and 2003, the Company also had the Sponsor Note, due 2009, with a balance of $103.8 million. The Sponsor Note bears interest at a fixed rate of 10.0%.
The interest rate on loans under the Revolver is, at the Company’s option, either (1) 1.25% over prime or (2) 2.75% over LIBOR. Under an amendment effective September 1, 2003, the interest rate margins over prime and LIBOR may be increased by 0.25% increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0 and (2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by 0.25% increments when the fixed charge coverage ratio is greater than (1) 1.75 to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of 0.75%). The interest rate was re-measured as of the effective date of September 1, 2003 under this amendment. At December 31, 2004, the Company’s weighted average rate on the Revolver was 6.50% under the prime option. A balance of $0.001 million was outstanding under the Revolver at December 31, 2004.
The estimated fair values of the outstanding Senior Notes and the Sponsor Note, based upon recently completed market trades, comparable borrowing rates and the relative seniority preference of the instruments under certain circumstances, were $66.9 million at December 31, 2004 and 2003 for the Senior Notes, and $64.4 million at December 31, 2004 and 2003 for the Sponsor Note. The Company does not expect changes in fair value of the Senior Notes or the Sponsor Note to have a significant effect on the Company’s operations, cash flow or financial position.
Foreign Currency Risk
The Company’s international subsidiaries operate in approximately 11 countries and use the local currencies as the functional currency and the U.S. dollar as the reporting currency. Transactions between the Company and the international subsidiaries are denominated in U.S. dollars. As a result, the Company has certain exposures to foreign currency risk. However, management believes that such exposure does not present a significant risk due to a relatively limited number of transactions and operations denominated in foreign currency. Approximately $126.1 million or 35.0% of the Company’s revenues are denominated in the international currencies. Transaction gains and losses on U.S. dollar denominated transactions are recorded within sundry expenses in the consolidated statements of operations and were not material.
The Company may use foreign forward currency-exchange rate contracts to minimize the adverse earnings impact from the effect of exchange rate fluctuations. No hedging activities existed at year-end 2004.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of BancTec, Inc.
We have audited the accompanying consolidated balance sheets of BancTec, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive (loss) income, stockholders’ deficit and cash flows for each of the years in the three-year period ended December 31, 2004. In connection with our audit of the consolidated financial statements, we have also audited the accompanying Schedule II, Valuation and Qualifying Accounts (“financial statement schedule”) as of December 31, 2004 and 2003 and for the years then ended. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States) . Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BancTec, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles . Also, in our opinion, the related financial statement schedule as of December 31, 2004 and 2003 and for the years then ended, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in note A to the consolidated financial statements, effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
BANCTEC, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
(In thousands)
See notes to consolidated financial statements.
BANCTEC, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS’ DEFICIT
(In thousands, except share data)
See notes to consolidated financial statements.
BANCTEC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
See notes to consolidated financial statements.
BANCTEC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See notes to consolidated financial statements.
BANCTEC, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
For the years ended December 31, 2004, 2003 and 2002 (In thousands, except share data)
See notes to consolidated financial statements.
BANTEC, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands)
See notes to Consolidated Financial Statements.
BANCTEC, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 2004, 2003, and 2002
NOTE A-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
BancTec, Inc. (BancTec or the Company), a Delaware corporation, is a worldwide provider of comprehensive enterprise content management, image capture devices, infrastructure support services and payment processing solutions. The Company helps customers create business efficiencies through innovative technology and services by combining advanced web-enabled imaging and workflow technologies with both BancTec-manufactured equipment and third-party equipment. These solutions are subsequently maintained and supported by the Company’s service operations. The Company is also a leading provider of personal computer maintenance services for major computer companies, government and corporate customers. See Note L for further discussion of Company business structure.
Principles of Consolidation
The consolidated financial statements include the accounts of BancTec, Inc. and its wholly-owned subsidiaries. The Company accounts for investments in which it does not exercise control (generally ownership of 50% or less) under the equity method of accounting. At December 31, 2003, retained earnings included $1.74 million of undistributed earnings for investments accounted for under the equity method. During 2003, the Company recorded $0.07 million of earnings from these investments in the consolidated statement of operations and received a dividend payment of $0.35 million. During 2004, the Company sold 100% of its investments accounted for under the equity method. Inter-company accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities and the reported amounts of revenues, costs and expenses during the reporting period. Actual results could differ from those estimates.
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 are similar instruments with original maturities in excess of three months and are valued at cost, which approximates market. Restricted cash at December 31, 2004 of $4.1 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 raw materials, labor, factory overhead, and purchased subassemblies. Cost is determined using the first-in, first-out and weighted average methods. The Company revised its standard costs for manufacturing inventory to effectively eliminate the purchasing burden component as of October 1, 2002. 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, additional 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 December 31, 2004, 2003, and 2002 were $13.6 million, $15.0 million, and $16.3 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 two 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 years ended December 31, 2004, 2003, and 2002 was $15.9 million, $21.1 million, and $24.0 million, respectively.
Intangible Assets
Beginning January 1, 2002, the Company adopted Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. 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. During 2002, the Company recorded as a cumulative 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 the carrying value of goodwill.
Components of the Company’s goodwill include amounts that are foreign currency denominated. These goodwill amounts are subject to translation at each balance sheet date. The Company records the change to its Accumulated Other Comprehensive Loss on the balance sheet. 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 year ended December 31, 2004.
Derivative Financial Instruments
Derivative financial instruments may be utilized by the Company to reduce interest rate or foreign-currency exchange rate risks. The Company has established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative financial instrument activities. The Company does not enter into financial instruments for trading or speculative purposes.
The Company accounts for derivative instruments in accordance with Statement of Financial Accounting Standards No. 133 Accounting for Derivatives Instruments and Hedging Activities (“SFAS 133”), which requires that all derivatives be recognized as assets and liabilities on the balance sheet and measured at fair value. The corresponding derivative gains or losses are reported based on the hedge relationship that exists. Changes in fair value derivative instruments that are not designated as hedges or that do not meet the hedge accounting criteria in SFAS 133 are required to be reported in earnings. At December 31, 2004, and at December 31, 2003, the Company was not a party to any derivative financial instruments.
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 year ended December 31, 2004 and 2003 were $7.8 and $12.5 million.
Income Taxes
The Company and its domestic subsidiaries file a consolidated Federal income tax return. 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. (See Note H for details on the impact of tax laws enacted during 2004.)
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’ deficit and comprehensive income. Transaction gains and losses are included in results of operations in “Sundry, net”. Foreign currency transaction gains for the years ended December 31, 2004, 2003, and 2002 were $0.2 million, $0.2 million, and $1.4 million, respectively.
Concentration of Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. Concentrations of credit risk for these instruments are limited due to the large number of customers comprising the Company’s customer base, and their dispersion across different geographic areas.
The Company sells its products to customers under specified credit terms in the normal course of business. These customers’ businesses can generally be classified as banking, personal computer manufacturers, financial services, insurance, healthcare, government agencies, utilities and telecommunications. During 2004, 2003, and 2002, the Company derived 17.4%, 15.7%, and 16.2%, respectively, of revenues from a single source. The loss of this revenue could have a material adverse effect on the Company. The revenue from this single source is entirely in the CNS segment.
The Company currently receives funds in advance for a significant portion of the Company’s services prior to the performance of the services they relate to and management does not currently consider this source to be a credit risk. Due to the diversity of the Company’s customers, management does not consider there to be a concentration of risk within any single classification. However, general economic conditions that cause customers in such industries 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.
The Company’s hardware and systems solutions are assembled using various purchased components such as PC monitors, minicomputers, encoders, communications equipment and other electronic devices. Certain products are purchased from sole- source suppliers. The Company generally has contracts with these suppliers that are renewed periodically. The Company has not experienced, nor does it foresee, any significant difficulty in obtaining necessary components or subassemblies; however, if the supply of certain components or subassemblies was interrupted without sufficient notice, the result could be an interruption of product deliveries.
Fair Value of Financial Instruments
The following estimated fair values of financial instruments have been determined by the Company using available market information and valuation methodologies:
Cash and short-term investments: Carrying amount approximates fair value due to the short-term nature of the instruments.
Short term borrowings: Carrying amount approximates fair value due to the short-term nature of the instruments.
Senior notes: The Company estimated fair value for 2004 based on an average value of recently completed market trades, resulting in a yield-to-maturity of approximately 19.5%. The number of actual trades is limited, therefore the result may vary if a widely-traded market environment existed.
Sponsor Note: The Company estimated fair value at December 31, 2004, using a yield-to-maturity of approximately 24.5%, based on the terms of the Sponsor Note.
The estimated fair values of the Company’s financial instruments at December 31 are as follows:
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:
Incentive Options. During the year ended December 31, 2003, the Company granted 45,000 incentive options. During the year ended December 31, 2004, 1,419,500 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 year ended December 31, 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.
Options and awards expire and terminate the earlier of 10 years from the date of grant or one month after the date the employee ceases to be employed by the Company. The weighted average remaining contractual life of the outstanding options is 8.7 years.
At December 31, 2004, options to purchase 1,807,000 shares were outstanding, of which 228,750 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.
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:
The fair value of each stock-option grant under the stock option plans was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions and results:
NEW ACCOUNTING PRONOUNCEMENTS
On December 16, 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair-value-based method. The Company is required to adopt SFAS No. 123(R) in the third quarter of fiscal 2005, beginning July 1, 2005. The Company is currently assessing the final impact of this standard on the company’s consolidated results of operations, financial position, and cash flows. This assessment includes evaluating option valuation methodologies and assumptions as well as potential changes to the Company’s compensation strategies.
In December 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which will become effective for the Company beginning January 1, 2006. This standard clarifies that abnormal amounts of idle facility expense, freight, handling costs and wasted material should be expensed as incurred and not included in overhead. In addition, this standard requires that the allocation of fixed production overhead costs to inventory be based on the normal capacity of the production facilities. The Company is currently evaluating the potential impact of this standard on its financial position and results of operations, but does not believe the impact of the change will be material.
On October 22, 2004, a new tax law was passed, the American Jobs Creation Act of 2004 (the “Jobs Creation Act”), which raised a number of issues with respect to accounting for income taxes. In response, on December 21, 2004, the FASB issued two FASB Staff Positions (FSP), FSP 109-1 - “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” and FSP 109-2 - “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” which became effective for the Company upon issuance.
The Jobs Creation Act provides a deduction for income from qualified domestic production activities, to be phased in from 2005 through 2010, which is intended to replace the existing extra-territorial income exclusion for foreign sales. In FSP 109-1, the FASB decided the deduction for qualified domestic production activities should be accounted for as a special deduction under SFAS No. 109, rather than as a rate reduction. Accordingly, any benefit from the deduction will be reported in the period in which the deduction is claimed on the tax return and no adjustment to deferred taxes at December 31, 2004, is required.
The Jobs Creation Act also creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and uncertainty remains as to how to interpret numerous provisions in the Act. FSP 109-2 addresses when to reflect in the financial statements the effects of the one-time tax benefit on the repatriation of foreign earnings. Under SFAS No. 109, companies are normally required to reflect the effect of new tax law changes in the period of enactment. FSP 109-2 provides companies additional time to determine the amount of earnings, if any, that they intend to repatriate under the Jobs Creation Act’s provisions. (See Note H for more discussion of the impact of the Jobs Creation Act, including the Company’s status on the repatriation of foreign earnings.)
Reclassification
Certain amounts have been reclassified from the prior years to conform to the current year presentation.
NOTE B - SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING TRANSACTIONS
The Consolidated Statement of Cash Flows included the following noncash investing and financing transactions:
NOTE C - DISCONTINUED OPERATIONS, RESTRUCTURING, IMPAIRMENT AND CHANGE IN ACCOUNTING ESTIMATE
Discontinued Operations.
On November 27, 2002, the Company completed the sale of its wholly-owned subsidiary, BancTec Japan (“BTJ”), to JAFCO MBO Co., Ltd. (“JAFCO”) pursuant to a Stock Purchase Agreement dated as of November 27, 2002, between the Company and JAFCO. The sale involved two separate transactions: (1) the purchase by JAFCO of 100% of the outstanding shares of BTJ for 6.5 billion yen, and (2) a one-time, up-front payment by BTJ to the Company of 4.0 billion yen under certain distribution and licensing agreements. Under such agreements, BTJ will continue to operate under the name “BancTec Japan”. After foreign currency conversions and transaction costs, the Company received approximately US $82.5 million in aggregate net proceeds. For financial statement purposes, the Company treated the sale as a discontinued operation under SFAS No. 144, and accordingly, financial statement presentation was made in accordance with APB Opinion No. 30. BTJ’s operating results have been segregated and reported as discontinued operations in the accompanying consolidated statements of income and cash flows, and related notes. During 2002, the Company recorded a gain on the disposal of the business of $63.0 (net of income tax expense of $0). Revenue from the discontinued operations of BTJ for the fiscal year 2002 was $63,213. Pretax income from the discontinued operations of BTJ for fiscal 2002 was $5,451. The assets related to BTJ were previously classified in the International segment (See Note L for the discussion of segment data).
Restructuring. As a part of the Company’s focus on cost efficiency, management has targeted and accrued for ongoing staff reductions. Severance charges are included in the cost of sales, selling, general and administrative and product development expense line items in the accompanying Consolidated Statements of Operations. As of December 31, 2004, approximately 720 employees have been terminated since 2001, including employees in production, product development, sales and marketing and other administrative functions.
Changes to the Company’s accrued severance liability during the years ended December 31, 2002, 2003 and 2004 are summarized as follows:
Impairment. Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net operating cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. The Company’s investments in non-marketable equity securities are monitored for impairment and are 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 was 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 Consolidated Statements of Operations for the year ended December 31, 2004.
Change in Accounting Estimate
During the quarter ended June 30, 2004, the Company recorded revenue of $4.3 million reflecting an adjustment arising out of a change in accounting estimate related to deferred revenue. The recording of deferred revenue requires the use of certain estimates, and new facts came to the attention of the Company, which necessitated the change in these estimates.
NOTE D - INVENTORIES
Inventory consists of the following:
NOTE E - DEBT AND OTHER OBLIGATIONS
Debt and other obligations consist of the following:
Revolving Credit Facility. The Company has a revolving credit facility (the “Revolver”) provided by Heller Financial, Inc. (“Heller”), which will mature on May 30, 2006. Effective May 7, 2003, the Company and Heller entered into an amendment to the Revolver which 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 December 31, 2004, the Company had $0.001 million outstanding under the Revolver and an outstanding balance on letters-of-credit totaling $4.0 million. The availability remaining under the Revolver that the Company can draw was $16.7 million at December 31, 2004 ($20.7 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) 1.25% over prime or (2) 2.75% over LIBOR. Under an amendment effective September 1, 2003, the interest rate margins over prime and LIBOR may be increased by 0.25% increments when the fixed charge coverage ratio falls below (1) 1.5 to 1.0 and (2) 1.25 to 1.0 and (total rate increase of 0.50%) or decreased by 0.25% increments when the fixed charge coverage ratio is greater than (1) 1.75 to 1.0, (2) 2.0 to 1.0, and (3) 2.25 to 1.0 (total rate decrease of 0.75%). The interest rate was re-measured as of the effective date of September 1, 2003 under this amendment. At December 31, 2004, the Company’s weighted average rate on the Revolver was 6.50% under the prime option.
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 December 31, 2004 of $4.1 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. Effective December 31, 2004, the Company and Heller amended the loan and security agreement to decrease the minimum fixed charge coverage ratio at December 31, 2004 from 1.1 to 1.0. The Company has experienced recent decreases in its fixed charge coverage ratio which has necessitated amendments to the Revolver agreement with Heller. It is anticipated that future amendments may be necessary should the fixed charge coverage ratio continue to decline. At December 31, 2004, the Company was in compliance with all covenants under the Revolver.
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 placing limitations on the Company’s ability to permit subsidiaries to incur certain debts, incur certain loans and liens, and engage in certain sale and leaseback transactions. During the year ended December 31, 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 2003.
Senior Subordinated Unsecured Sponsor Note. The Company’s $160.0 million Sponsor Note is issued in U.S. dollars and 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 June 2000 through September 2001 quarterly periods resulting in an increase in 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 elected not to defer the quarterly payments since September 2001 and currently does not intend to elect deferral of the quarterly payments in the near future. In accordance with the terms of the Sponsor Note, on December 6, 2002, the Company made a $90 million principal payment on the Sponsor Note. A holder of the Senior Notes had sought to contest this payment. See discussion under Item 3, Legal Proceedings. The Company wrote off a proportionate share of deferred financing fees totaling $3.8 million in 2002.
Capital Leases. During the first quarter of 2003, the Company entered into a capital lease for $2.4 million that pertained to computer hardware. During the second quarter of 2004, the Company entered into a second capital lease for $0.2 million that also 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 Consolidated Balance Sheets. Amortization of assets recorded under capital leases is included in depreciation expense. The current obligations under capital leases are classified in the Current Liabilities section of the Consolidated Balance Sheets and the non-current portion of capital leases are included in Other Liabilities. At December 31, 2004, the Company had capital lease balances outstanding of $0.5 million, of which $0.3 million was classified as current and $0.2 million was classified as long-term.
The Company had no outstanding foreign-credit balances as of December 31, 2004.
As of December 31, 2004 the future maturities of debt are as follows:
The Company paid cash totaling $17.8 million, $19.7 million, and $28.5 million, for interest during the twelve months ended December 31, 2004, 2003, and 2002, respectively. During the years ended December 31, 2004, 2003 and 2002, the Company capitalized no interest costs.
NOTE F - REDEEMABLE PREFERRED STOCK
SERIES A PREFERRED STOCK
In consideration for amending the Company’s credit agreements with its Lenders, in September 2000, the Company issued 100,000 shares of $0.01 par value Series A Preferred Stock to WCAS, its primary owners. In exchange, WCAS contributed an additional $15.0 million in cash to the Company. Dividends on the Series A Preferred accrue quarterly at an annual dividend rate of 7.0% of the then Stated Value. The Stated Value equals $150.00 per share, plus accumulated and unpaid dividends. Dividends are paid when declared by the Company’s Board of Directors. The aggregate liquidation preference/redemption value is $15.0 million, plus accumulated and unpaid dividends. The Company has the right to redeem the Series A Preferred at any time by paying for each share the Stated Value per share as of the redemption date. In addition, upon the occurrence of certain events, as defined, and upon the approval of a majority of the holders of the Series A Preferred, the Company would be required to redeem the shares. Due to the redemption rights at the option of the holder, the Series A Preferred Stock is classified as temporary equity. An amendment to the agreement covering the Series A preferred stock to remove the mandatory redemption date was approved by the Board of Directors on March 31, 2004. Each share of Series A Preferred includes a warrant to purchase between 2.5 and 7.75 shares of Common Stock at $0.01 per share. Common stock exercisable by the warrant totals 750,000 shares and may be exercised at any time from the date of purchase.
The Company allocated the proceeds from the Series A preferred-stock issuance based upon the relative fair-value of the preferred stock and warrants which resulted in recording preferred stock of $11.3 million and warrants of $3.7 million. The related discount was being accreted over a period of 8 years through March 31, 2004, when the mandatory redemption provision was removed from the Series A Preferred Stock.
On November 1, 2002, Intermediate Holding contributed $100,000 to the Company in exchange for 667 shares of Series A Preferred Stock of the Company. These shares do not include warrants.
For the years ended December 31, 2004 and 2003, accretion of the related discount and accrued but unpaid dividends totaled $1.4 million and $1.7 million, respectively, increasing the carrying amount to $18.0 million and $16.6 million, respectively. As of December 31, 2004, the stated value of the Series A Preferred, including accumulated but unpaid dividends, was $201.32.
SERIES B PREFERRED STOCK
In February 2001, the Company issued 35,520 shares of $0.01 par value Series B Preferred Stock (“Series B Preferred”) to its primary owners, WCAS. In exchange, WCAS contributed an additional $5.3 million in cash to the Company. Dividends on the Series B Preferred accrue quarterly at an annual dividend rate of 25.0% of the then “Stated Value.” The Stated Value equals $150.00 per share, plus accumulated and unpaid dividends. Dividends are paid when declared by the Company’s Board of Directors. The aggregate liquidation preference/redemption value at December 31, 2004, is $13.5 million, including accumulated and unpaid dividends. The Company has the right to redeem the Series B Preferred at any time by paying for each share the Stated Value per share as of the redemption date. At December 31, 2003, the Series B Preferred Stock was classified as temporary equity as the preferred security holders comprised fifty percent of the Board of Directors. On March 31, 2004, a seventh member was elected to the Board of Directors who is not a preferred security holder. As a result, the preferred security holders no longer control the Board of Directors and the Series B Preferred Stock was then classified as part of permanent equity. Each share of Series B Preferred is convertible into shares of Common Stock at any time. The number of shares of Common Stock is determined by multiplying the number of shares being converted by $150.00 and dividing the result by $8.325 per share. The conversion rate is subject to various adjustments (for anti-dilution). The Company is required to keep available approximately 640,000 common shares for issuance upon conversion of all outstanding shares of Series B Preferred.
For the years ended December 31, 2004 and 2003, accrued but unpaid dividends totaled $2.9 million and $2.3 million, respectively. As of December 31, 2004, the stated value of the Series B Preferred, including accumulated but unpaid dividends, was $380.63.
NOTE G - OTHER ACCRUED EXPENSES AND LIABILITIES
Other accrued expenses and liabilities consist of the following:
NOTE H - TAXES
In October 2004, the Jobs Creation Act was enacted. One of the provisions of this act provides a deduction for income from qualified domestic production activities (“qualified production income” or QPI). The deduction, which cannot exceed 50 percent of annual wages paid, is phased in as follows: 3 percent of QPI in 2005-2006, 6 percent in 2007-2009, and 9 percent in 2010 and thereafter. The Jobs Creation Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales with a 20 percent phase-out in 2005, 40 percent in 2006 and 100 percent thereafter. The impact on the Company’s tax rate of the new manufacturing deduction at a fully phased-in rate of 9 percent has not yet been determined.
The Jobs Creation Act also creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and uncertainty remains as to how to interpret numerous provisions in the Jobs Creation Act.
As of December 31, 2004, the Company was not in a position to decide on whether, and to what extent, foreign earnings that have not yet been remitted to the U.S. may be repatriated.
The income tax expense (benefit) on income (loss) from continuing operations consists of the following:
The difference between the income tax provision on income (loss) from continuing operations computed at the statutory federal income tax rate and the financial statement provision for taxes is summarized as follows:
The Company paid cash totaling $2.8 million, $1.5 million, and $0.3 million for income taxes on continuing operations during the years ended December 31, 2004, 2003 and 2002, respectively.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2004 and 2003 are presented below (dollars in thousands):
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.
Components of the valuation allowance are as follows.
Company’s effective tax rate was (377.7%), (176.1%), and 5.1% for the years ended December 31, 2004, 2003, and 2002, respectively.
The Company’s net operating loss carryforwards of $124.6 million expire as follows: $5.8 million in the period from 2005 through 2007, $0.3 million in the periods from 2008 through 2013, $0.1 million in the period from 2014 through 2019, $88.8 million in the period from 2020 through 2025, and $29.6 million with no expiration.
Components of income (loss) from continuing operations before income tax expense (benefit) are as follows:
Undistributed earnings of foreign subsidiaries included in continuing operations were approximately $17.7 million, $25.5 million, and $17.5 million, at December 31, 2004, 2003 and 2002, respectively. No taxes have been provided on the undistributed earnings as they are considered to be permanently reinvested.
NOTE I - EMPLOYEE BENEFIT PLANS
The Company’s Employees’ Savings Plan allows substantially all full-time and part-time U.S. employees to make contributions defined by Section 401(k) of the Internal Revenue Code. Beginning in February 2001, the Company’s 401(k) Plan changed to match 50.0% of the participants’ qualifying total pre-tax contributions, up to a maximum that is tied to the Company’s achievement of certain financial objectives. No amounts were expensed under the plan for the years ended December 31, 2004, 2003 and 2002.
The Company’s subsidiary in United Kingdom provides pension benefits to retirees and eligible dependents. Employees eligible for participation include all full-time regular employees who are more than three years from retirement. A retirement pension or a lump-sum payment may be paid dependent upon length of service at the mandatory retirement age. The Company accrues the cost of these benefits over the service lives of the covered employees based on an actuarial calculation. The Company uses a December 31 measurement date for this plan.
The following table provides a reconciliation of the benefit obligation, plan assets and funded status of the pension fund.
The components of the net periodic benefit cost are as follows:
The net pension liability at December 31, 2004 and 2003 was $18.3 million and $13.4 million, respectively. This liability is classified in Other Liabilities in the Consolidated Balance Sheets. The increase in minimum liability included in other comprehensive loss for the years ended December 31, 2004, 2003 and 2002 was $4.5 million, $6.2 million and $1.2 million, respectively.
The weighted average asset allocations for the Company’s defined benefit plans at December 31, 2004 and 2003, are as follows:
The Company’s investment policy related to the defined benefit plans is to continue to increase the percentage of its funds held in government gilts and highly rated bonds as a means to reduce the overall risk of assets held in the funds and to better balance the allocation of fund assets. During 2004, all contributions made to the fund were in these categories.
The Company’s funding methods are based on governmental requirements and differ from those methods used to recognize pension expense. The Company expects to contribute $1.3 million to the pension plan during 2005 and expects this level of funding to continue in future periods.
Pension benefit payments expected to be paid to plan participants are as follows:
NOTE J - 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.
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 year ended December 31, 2003 and 2004 are summarized as follows:
NOTE K - COMMITMENTS AND CONTINGENCIES
Leases. The Company leases certain sales and service office facilities and equipment under non-cancelable operating leases expiring through year 2010. Total Company rent expense for the years ended December 31, 2004, 2003, and 2002 was $8.4 million, $7.9 million, and $8.9 million, respectively.
Future minimum payments under non-cancelable operating leases, net of expected sublease income of $0.3 million, $0.2 million, $0.2 million, and $0.2 million for 2005, 2006, 2007, and 2008, respectively, are as follows:
The Company believes that its facility leases can be either renewed or replaced with alternate facilities at comparable cost.
Litigation. A lawsuit captioned Cerberus International, Ltd., et al. vs. BancTec, Inc., et al. (Case No. 03600287) was filed on January 28, 2003 in the Supreme Court of the State of New York for the County of New York naming as defendants the Company and certain of its affiliates. The complaint alleges that the Company improperly made a payment to the holder of the Sponsor Note and sought damages of not less than $89 million as a result of the alleged improper payment and the imposition of a constructive trust on monies paid by the Company to the holder of the Sponsor Note. The Company’s $90 million payment to the holder of the Sponsor Note was disclosed in the Company’s Current Report on Form 8-K dated November 27, 2002.
On May 5, 2004, the Supreme Court granted the Company’s motion for summary judgment dismissing the plaintiffs’ complaint in its entirety. On or about November 8, 2004, the plaintiffs/appellants filed their brief with the appellate division of the New York Supreme Court. On March 3, 2005, the Supreme Court of New York, Appellate Division affirmed the lower court’s decision in favor of BancTec.
The Company and its subsidiaries are parties to various other legal proceedings. Although the ultimate disposition of such
proceedings is not presently determinable, in the opinion of the Company, any liability that may ensue would not have a material adverse impact on the financial position or results of operations or cash flows of the Company.
NOTE L - BUSINESS SEGMENT DATA
Management has chosen to structure the organization around product lines and geography.
The Company has segmented its operations based on geographical U.S. Solutions (“USS”) and International Solutions (“INTL”), and product lines, Computer and Network Services (“CNS”). INTL reporting includes both the U.S. and international operations of Plexus® products (“Plexus”). For 2003 and 2004, CNS reporting includes start-up service operations in Canada and Europe.
US Solutions and International Solutions. USS and INTL offer similar systems-integration and business-process solutions and services and market to similar types of customers. These segments offer similar systems integration and business process solutions and services, and market to similar types of customers. The solutions offered primarily involve high-volume transaction processing using advanced technologies that capture, process and archive paper and electronic documents. The Company’s powerful, high-volume integrated systems deliver important benefits to some of the world’s largest credit card companies and major banks. In addition, these segments provide their products and services to other customers, including financial services companies and insurance providers, telecommunications companies, utility companies, governmental agencies, and retail companies. The Company combines its extensive business application knowledge with a full range of software and equipment offerings for complex transaction processing environments. The Company’s integrated systems generally incorporate advanced applications software developed by the Company and by third parties. These solutions may also include hardware developed and manufactured by the Company as well as by third parties. Key applications provided by USS and INTL focus around the following process services and solutions: (1) Enterprise Content Management, (2) Image Capture, (3) Support Services, and (4) Payment Processing.
Computer and Network Services. CNS provides quality integrated support services to the evolving Information Technology industry, with focused deployment and ongoing support solutions for the OEM, Enterprise and Fortune marketplaces. CNS provides coverage in North America and Europe, and customers include OEM providers, defense and aerospace companies, strategic outsourcing organizations, and consumer electronics manufacturers.
Data excludes the impact of discontinued operations.
Whenever possible, the Company uses market prices to determine inter-segment pricing. Other products are transferred at cost or cost plus an agreed upon mark-up.
Table 1-New Segments
NOTE M - GEOGRAPHIC OPERATIONS
The Company operates in the following geographic areas: the United States, the UK, and other international areas consisting primarily of Canada, France, Sweden, Germany, and the Netherlands. Inter-area sales to affiliates are accounted for at established transfer prices.
Sales to unaffiliated customers and affiliates for the years ended December 31, 2004, 2003 and 2002, and long-lived assets, other than deferred taxes, at the end of each of those periods, classified by geographic area, are as follows:
NOTE N - SUMMARIZED QUARTERLY DATA (UNAUDITED)
NOTE O - ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss is as follows:
For the year ended December 31, 2004, other comprehensive loss consisted of foreign-currency translation adjustments related to the Company’s international operations (a gain of $1.6 million) and minimum pension liability related to the Company’s subsidiary in the United Kingdom ($0.6 million).
BANCTEC, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Financial Statements and Independent Registered Public Accounting Firm’s Report
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2004 and December 31, 2003
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Stockholders’ Deficit for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Comprehensive (Loss) Income
Notes to Consolidated Financial Statements
Supplemental Schedules
Schedule II-Valuation and Qualifying Accounts for the years ended December 31, 2004, 2003 and 2002
All other schedules have been omitted as the required information is inapplicable, not required, or the information is included in the financial statements and notes thereto.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
During the audit of the Company’s 2000 financial statements, the Company’s certifying accountant, Deloitte & Touche LLP (D&T) noted what D&T considered to be material weaknesses in internal-control design and in the operation of internal controls. See Current Report on Form 8-K filed with the Securities and Exchange Commission on November 13, 2001 for additional information regarding this item and the subsequent change in the Company’s independent accountant. The Company’s current independent accountant, KPMG, LLP (KPMG), also informally noted certain internal-control weaknesses as a result of the 2001 audit, some of which are the same weaknesses as noted by D&T in their report.
The Company has addressed the individual internal-control weaknesses noted by D&T and KPMG, and analysis of internal control factors continues on an ongoing basis. Steps that have been implemented to address internal-control weaknesses include policies covering 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 has begun to put in place procedures addressing the adequacy of disclosure controls, including obtaining certifications from each member of management involved in the preparation and review of this Form 10-K. The Company believes that it has implemented adequate controls and procedures for the preparation of this report.
Within the 90 days prior to the filing date of this report, the Chief Executive Officer and the Chief Financial Officer of the Company, with the participation of the Company’s management, continued to evaluate the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the evaluation completed to date, and the new procedures put in place, the Chief Executive Officer and the Chief Financial Officer believe that the Company’s disclosure controls and procedures are effective in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report. The Company will continue to evaluate disclosure controls on an ongoing basis.
Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process.
There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls, known to the Chief Executive Officer or the Chief Financial Officer, subsequent to the date of the evaluation.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF BANCTEC, INC.
The following table sets forth the names, ages, and positions of each of the directors and executive officers of the Company as of April 8, 2005.
The Board of Directors elects executive officers annually. No family relationships exist among the directors or executive officers of the Company. Except for traffic offenses or other minor offenses, no director or executive officer has been convicted or named in a criminal proceeding during the past five years.
Mr. Clark has been a director of the Company since March 2004 and Chief Executive Officer since September 2004, when he joined BancTec from EDS. Mr. Clark retired from EDS in 2004 as a Senior Vice President and President of EDS Financial Global Industry Solutions. Mr. Clark is also director of Carreker Corp., a provider of software solutions to the financial industry and FundsXpress, a software provider to the financial industry.
Mr. Cushman has been Senior Vice President and Chief Financial Officer since February 18, 2005. Mr. Cushman joined BancTec, Inc. in November 2004 as Vice President of Finance. Mr. Cushman previously did strategic development work for Metromedia Fiber Network, Inc. and before joining Metromedia, Mr. Cushman was the Chief Financial Officer, Senior Vice President, Secretary and Treasurer for GroceryWorks, Inc and Evercom, Inc. Prior to this time, Mr. Cushman was Director of Business Development at Electronic Data Systems Corporation, after holding a number of financial positions, including Group Financial Officer, Controller, and Financial Manager & Supervisor.
Mr. Minicucci has been a director of the Company since July 1999. Mr. Minicucci also serves as a Managing Member of WCAS VIII Associates LLC, the general partner of Welsh, Carson, Anderson & Stowe VIII, L.P. (a private investment company) and as a director of Amdocs Limited (a telecom customer care and billing software and services company). Mr. Minicucci has served as a General Partner of Welsh, Carson, Anderson & Stowe since 1993.
Mr. Fernandes has been a director of the Company since March 2003. Mr. Fernandes retired as Vice Chairman of Electronic Data Systems Corporation (EDS), a global services company, in 1998, after serving on the Board of Directors of EDS since 1981. After retiring from EDS, Mr. Fernandes founded Convergent Partners, a venture-capital fund focusing on buyouts of technology-related companies. He also served as Chairman and CEO of GroceryWorks, Inc, an internet grocery-fulfillment company until 2001. He currently serves on the Boards of Directors of 7-Eleven, Inc., a worldwide operator, franchisor and licensor of convenience stores, webMethods, Inc., a software-integration company listed on NASDAQ, and Anacomp, Inc. Mr. Fernandes is currently the Chairman and President of FLF Real Estate Ventures.
Mr. Lee has been a director of the Company since January 2002. He joined WCAS as an Associate in July 1999 and focuses on investments in the information services and healthcare industries. From July 1995 to June 1999, Mr. Lee was employed by Goldman, Sachs & Company where he worked in the High Technology and Mergers & Acquisitions groups.
Mr. Swani has been a director of the Company since December 2000. Mr. Swani joined Welsh, Carson, Anderson & Stowe in July 1999 and became a General Partner in October 2001. Mr. Swani also served as a principal of Fox Paine & Company (a San Francisco-based buyout firm) from June 1998 to June 1999 and worked in the mergers and acquisitions department of Morgan Stanley & Co. (a global financial services firm) from August 1994 to June 1998. Mr. Swani is also a director of Global Knowledge Networks, Inc. and Valor Telecommunications, LLC.
Audit Committee
On March 15, 2005, the Audit Committee consisted of Sanjay Swani, Eric J. Lee, and Gary J. Fernandes. No member of the Audit Committee was an officer of the Company. No member of the Audit Committee was formerly an officer of the Company.
Code of Business Conduct and Ethics
The Company has adopted a Code of Business Conduct and Ethics that applies to all of the Company’s directors, officers and employees, including its principal executive officer, principal financial officer, principal accounting officer and controller. The Code is posted on the Company’s website at www.banctec.com. The Company intends to disclose any amendments to the Code by posting such amendments on its website. In addition, any waivers of the Code for directors or executive officers of the Company will be disclosed in a report on Form 8-K.
Section 16(a) Beneficial Ownership Reporting Compliance
Not applicable.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information regarding compensation earned during the fiscal years ended December 31, 2004, 2003 and 2002, by the Company’s Chief Executive Officer and each of the Company’s other most highly compensated executive officers earning in excess of $100,000 per year (based upon salary and bonus earned during the fiscal year ended December 31, 2004).
(1) Reflects bonus earned during each fiscal year.
(2) Amount represents options to purchase 1,050,000 shares of our common stock granted September 14, 2004.
(3) Includes cash compensation received for severance payments to Mr. Crisman (2004).
(4) Mr. Crisman served as President and Chief Executive Officer from May 2001 to September 2004 and Director from September 2004 to April 7, 2005. Mr. Crisman terminated employment effective September 9, 2004.
(5) Mr. Stone serviced as Senior Vice President and Chief Financial Officer from May 2001 to February 2004. Mr. Stone
terminated employment effective February 18, 2004.
Option Grants in 2004
During 2004, Mr. Clark was granted a total of 1,050,000 options.
Aggregated Option Exercises in 2004 and Fiscal Year-End Option Values
No options were exercised by any named executive officer in 2004. The following table provides information related to the number and value of options held by the named executive officers at the end of 2004.
Compensation of Directors
During 2004, director’s fees of $10,000 were paid to Mr. Clark for his service on the board of directors prior to becoming Chief Executive Officer. The Company has no standard arrangements under which director’s receive compensation, and no other directors fees were paid during 2004.
Employment Agreements
The Company does not have any employment agreements with any named officers.
Compensation Committee and Option Committee Interlocks and Insider Participation
From January 1, 2002 through December 31, 2004, the Compensation Committee was composed of Robert A. Minicucci.
From January 1, 2002 through December 31, 2004, the Option Committee was composed of Robert A. Minicucci.
No member of the Compensation Committee or the Option Committee was an officer or employee of the Company. No member of the Compensation Committee or the Option Committee was formerly an officer of the Company.
REPORT OF THE COMPENSATION COMMITTEE
Compensation Policy and Executive Compensation. The executive compensation program is designed to attract, motivate, reward and retain the executive officers needed to achieve the Company’s business objectives, to increase profitability and to provide value to the stockholders. The program has been structured and implemented to provide competitive compensation opportunities and various incentive awards based on company and individual performance. The executive compensation program is composed of three principal components: base salary, short-term incentive awards and long term incentive awards.
Base Salary. The base salary for each executive officer is determined at levels considered appropriate for comparable positions at similar companies.
Short-Term Incentive Awards. To reinforce the attainment of Company goals, the Committee believes that a substantial portion of the annual compensation of each executive officer should be in the form of variable incentive pay. The Company maintains an incentive plan under which the executive officers may earn an award as a percentage of their base compensation, if the Company meets the EBITDA profit objective set by the Compensation Committee at the beginning of the fiscal year.
Long-Term Incentive Awards. Under the 2000 Plan, stock options are awarded based on an individual’s level of responsibility within his or her area, such individual’s executive development potential and competitive market norms. Options granted under the 2000 Plan are granted at the fair market value of the stock on the date of grant.
2004 Total Compensation for the Chief Executive Officer. J. Coley Clark. When Mr. Clark became the company’s Chief Executive Officer in September 2004, the Committee designed a compensation plan which was consistent with that provided to the company’s other executive officers. Although a significant portion of Mr. Clark’s potential future compensation consists of bonus plan payments based on company performance, the Committee did not rely entirely on predetermined formulas or a limited set of criteria when it determined the compensation of the company’s Chief Executive Officer.
The Committee designed a compensation package for Mr. Clark that provided a competitive salary with the potential of significant bonus plan compensation in the event the company performed well under his leadership. For 2004, Mr. Clark’s annual salary level as Chief Executive Officer was $450,000 with no bonus compensation paid in 2004.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of March 15, 2005 regarding the ownership of Common Stock, Class A Common Stock, and Preferred Stock of: (1) each person who is known by the Company to be the beneficial owner of more than five percent of the outstanding shares of the named class of Stock; (2) each director of the Company; (3) each executive officer named in the Summary Compensation Table; and (4) all executive officers and directors of the Company as a group. Percentage of ownership is based on 17,003,838 shares of Common Stock and 1,181,946 shares of Class A Common Stock (both issued and outstanding at March 15, 2004), 100,667 shares of Series A Preferred Stock (Preferred A), and 35,520 shares of Series B Preferred Stock (Preferred B) outstanding as of March 15, 2004. The assumed exercise of the Series A Preferred warrants (“Series A Warrants”) and the assumed conversion of the Series B Preferred (“Series B Conversion Rights”) results in 750,000 and 640,000 additional shares, respectively, of Common Stock. Additionally, the assumed exercise of options results in 185,150 additional shares of Common Stock. Included in the Number of Shares Beneficially Owned are shares attributable to stock options, stock warrants, and conversion rights that are exercisable as of, or will be exercisable within 60 days after, March 15, 2005.
* Less than one percent.
(1) BancTec Intermediate Holding, Inc. has sole investment and sole voting power with respect to the shares of Stock shown.
(2) Common Stock includes 17,003,838 shares of Common Stock, 1,181,946 shares of Class A Common Stock, 750,000 shares of Common Stock (Series A Warrants), and 640,000 shares of Common Stock (Series B Conversion Rights).
(3) 100,000 shares of Series A Preferred includes a warrant to purchase between 2.5 and 7.75 shares of Common Stock. Common Stock exercisable by the warrants totals 750,000 shares.
(4) Each share of Series B Preferred Stock includes the right to convert into Common Stock. The number of shares of Common Stock is determined by multiplying the number of shares being converted by $150 and dividing the result by $8.325 per share. The conversion rate is subject to various adjustments.
(5) BancTec Upper-Tier Holding, LLC holds 100% of the outstanding capital stock of BancTec Intermediate Holding, Inc., which in turn holds 100% of all classes of capital stock, including warrants.
(6) Welsh, Carson, Anderson & Stowe VIII, L.P holds the majority interest in BancTec Upper-Tier Holding, LLC.
(7) WCAS Capital Partners III, L.P. holds a minority interest in BancTec Upper-Tier Holding, LLC.
(8) WCAS Information Partners, L.P. holds a minority interest in BancTec Upper-Tier Holding, LLC.
(9) Mr. Minicucci is a managing member of WCAS VIII Associates LLC, the general partner of Welsh, Carson, Anderson & Stowe VIII, L.P. Mr. Minicucci disclaims beneficial ownership of such shares.
(10) Mr. Lee is not a general partner of Welsh, Carson, Anderson & Stowe VIII.
(11) Mr. Fernandes holds a minority interest in BancTec Upper-Tier Holding, LLC. Mr. Fernandes disclaims beneficial ownership of such shares.
(12) Mr. Holland holds a minority interest in BancTec Upper-Tier Holding, LLC. Mr. Holland disclaims beneficial ownership of such shares.
(13) Mr. Swani is a managing member of WCAS VIII Associates LLC, the general partner of Welsh, Carson, Anderson & Stowe VIII, L.P. Mr. Swani disclaims beneficial ownership of such shares.
(14) Mr. Crisman holds a minority interests in BancTec Upper-Tier Holding, LLC. Mr. Crisman disclaims beneficial ownership of such shares.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
KPMG LLP, and their respective affiliates (collectively, the “KPMG Entities”) have been retained as the company’s independent auditors for the 2004 fiscal year. The following table presents the aggregate fees billed by the KPMG Entities, for services provided during 2003 and 2004:
(1)
Audit fees consisted of audit work performed in the preparation of the financial statements, as well as work that generally only the independent auditor can reasonably be expected to provide, such as statutory audits and reviews of interim financial information.
(2)
Tax fees consist principally of assistance related to tax compliance and reporting.
(3)
All audit and audit-related fees were approved by the Audit Committee.
(4)
The Audit Committee approves in advance all audit services, audit-related services and tax-related services provided by the Company’s independent public accountants. Pursuant to the pre-approval policy adopted by the Board of Directors in 2003, the Audit Committee also approves all other services provided by the independent public accountants in advance on a case-by-case basis. All engagements of the independent public accountants in 2003 and 2004 were pre-approved pursuant to the policy.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (2) Financial Statements: See Index to Financial Statements and Schedules.
(b) Reports on Form 8-K:
The Company filed a Current Report on Form 8-K dated September 9, 2004, regarding the termination of Craig D. Crisman as Chief Executive Officer and the appointment of J. Coley Clark as Chief Executive Officer.
(c) Exhibits:
3.1 - Amended and Restated Certificate of Incorporation, incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
3.2 - By-Laws, incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
4.1 - Certificate of Designations, Preferences and Rights of Series A Preferred Stock, incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000.
4.2 - Securities Purchase Agreement dated as of September 22, 2000, incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000.
4.3 - Certificate of Designations, Preferences and Rights of Series A and B Preferred Stock, incorporated by reference to Exhibit 4.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.
4.4 - Securities Purchase Agreement dated as of February 27, 2001, incorporated by reference to Exhibit 4.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.
4.5 - Indenture dated May 22, 1998 by and between the Company and The First National Bank of Chicago, incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-4 dated August 28, 1998.
4.6 - Exchange and Registration Rights Agreement dated May 22, 1998 by and among the Company, Chase Securities, Inc., Goldman, Sachs & Co. and NationsBanc Montgomery Securities LLC, incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-4 dated August 28, 1998.
4.7 - Senior Subordinated Note dated July 22, 1999, among Colonial Acquisition Corp., a predecessor in interest to the Company, WCAS CP III and the several Purchasers named in Schedules I and II thereto, incorporated by reference to Exhibit 4.7 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.1 - Loan Documents dated July 22, 1999, among the Company, Chase Bank of Texas, as Agent, and Welsh, Carson, Anderson & Stowe, as amended, incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
10.2 - First Amendment and Waiver dated January 21, 2000 to Loan Documents, incorporated by reference to Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
10.3 - Second Amendment and Waiver dated May 15, 2000 to Loan Documents, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000.
10.4 - Third Amendment and Waiver dated September 15, 2000 to Loan Documents, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000.
10.5 - Stock Subscription Warrant, incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000.
10.6 - BancTec, Inc. 2000 Stock Plan, incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000.
10.7 - Loan and Security Agreement, dated as of May 30, 2001, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2001.
10.8 - First Amendment to Loan and Security Agreement, dated as of November 8, 2001, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2001.
10.9 - Second Amendment to Loan and Security Agreement, dated as of February 5, 2002, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.10 - Third Amendment to Loan and Security Agreement, dated as of July 30, 2002, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.11 - Fourth Amendment to Loan and Security Agreement, dated as of November 27, 2002, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed as of November 27, 2002.
10.12 - Loan and Security Agreement-Waiver, Consent and Amendment Relating to BancTec Restructuring, dated as of November 1, 2002, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed as of November 27, 2002.
10.13 - Stock Purchase Agreement, dated as of November 27, 2002, between BancTec, Inc. and JAFCO MBO Co., Ltd., incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed as of November 27, 2002.
10.14 - Fifth Amendment to Loan and Security Agreement, dated as of May 7, 2003, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003.
10.15 - Sixth Amendment to Loan and Security Agreement, dated as of September 1, 2003, between Heller Financial, Inc. and BancTec, Inc., incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2003.
10.16 - Certificate of Designations, Preferences and Rights of Series A and B Preferred Stock, dated March 31, 2004.
10.17 - Loan and Security Agreement-Waiver and Consent, dated as of August 9, 2004, between Heller Financial, Inc. and BancTec, Inc.
10.18 - Loan and Security Agreement - December 31, 2004 Amendment to Paragraph B of Financial Covenants Rider to Loan and Security Agreement, dated as of December 31, 2004, between Heller Financial, Inc. and BancTec, Inc.
21.1 - Subsidiaries of Registrant
31.1 - Certificate of Chief Executive Officer pursuant to Rule 15d-14(a) under the Securities Exchange Act.
31.2 - Certificate of Chief Financial Officer pursuant to Rule 15d-14(a) under the Securities Exchange Act.
32.1 - Certificate of Chief Executive Officer pursuant to 18 USC 1350 and Rule 15d-14(a) under the Sarbanes-Oxley Act.
32.2 - Certificate of Chief Financial Officer pursuant to 18 USC 1350 and Rule 15d-14(a) under the Sarbanes-Oxley Act.
SCHEDULE II
BANCTEC, INC.
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 2004, 2003 and 2002
(a) Write-off of uncollectible accounts.
(b) Severance and related payments.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BancTec, Inc.
Dated: April 8, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated:
Signature
Title
Date
/s/ J. Coley Clark
President and Chief Executive Officer (Principal Executive Officer); and Director
April 8, 2005
J. Coley Clark
/s/ Jeffrey D. Cushman
Senior Vice President, Chief Financial Officer, and Treasurer (Principal Accounting Officer); and Director
April 8, 2005
Jeffrey D. Cushman
/s/ Robert A. Minicucci
Chairman of the Board and Director
April 8, 2005
Robert A. Minicucci
/s/ Eric J. Lee
Director
April 8, 2005
Eric J. Lee
/s/ Gary J. Fernandes
Director
April 8, 2005
Gary J. Fernandes
/s/ Sanjay Swani
Director
April 8, 2005
Sanjay Swani
/s/ Craig D. Crisman
Director
April 8, 2005
Craig D. Crisman