**SECURITIESAND EXCHANGE COMMISSION**

**Washington D.C. 20549**

 

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** **

**FORM10-K**

 
| **(Mark  one)**                                                                                                                                                                         |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                                                                              | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                    |
| **For the fiscal year ended November 30, 2002**                                                                                                                                         |
|                                                                                                                                                                                    |
| **OR**                                                                                                                                                                                  |
|                                                                                                                                                                                    |
| **o**                                                                                                                                                                                   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                    |
| **For  the transition period from              to            ** |
|                                                                                                                                                                                    |
| **Commission File No.:  000-24413**                                                                                                                                                |

 

**TROYGROUP, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                     |   | **33-0807798**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or  organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **2331 South Pullman Street  Santa Ana, California**             |   | **92705**                             |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |

 

Registrant’stelephone number, including area code:  **(949)250-3280**

 

Securitiesregistered pursuant to Section 12(b) of the Act: **None**

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

**Common Stock, $.01 par value**

** **

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.   Yes  ýNo  o

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  ý

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes  o  No  ý

 

As of February 28,2003, 10,649,092 shares of the Registrant’s Common Stock were outstanding.  The aggregate market value of theRegistrant’s outstanding common stock as of that date (based upon the last saleprice of a share of common stock on that date reported in the over-the-countermarket), excluding outstanding shares beneficially owned by directors andexecutive officers, was $6,904,770

** **

**DOCUMENTS INCORPORATED BYREFERENCE**

** **

**NONE**

 

 

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**TABLEOF CONTENTS**

 
| Item 1.   | BUSINESS                                                                                    |
|-----------|---------------------------------------------------------------------------------------------|
|      | General                                                                                     |
|      | Organization  and Development of Business                                                   |
|      | Products                                                                                    |
|      | Business  Strategies                                                                        |
|      | Research and Product  Development                                                           |
|      | Support  Services                                                                           |
|      | Sales and  Marketing                                                                        |
|      | Strategic  Relationships                                                                    |
|      | Competition                                                                                 |
|      | Intellectual  Property                                                                      |
|      | Environmental and Regulatory  Matters                                                       |
|      | Employees                                                                                   |
|      |                                                                                        |
| Item 1A.  | CERTAIN IMPORTANT  FACTORS                                                                  |
|      |                                                                                        |
| Item 2.   | PROPERTIES                                                                                  |
|      |                                                                                        |
| Item 3.   | LEGAL PROCEEDINGS                                                                           |
|      |                                                                                        |
| Item  4.  | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        |
|      |                                                                                        |
| Item  5.  | MARKET  FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                 |
|      |                                                                                        |
| Item 6.   | SELECTED FINANCIAL  DATA                                                                    |
|      |                                                                                        |
| Item  7.  | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|      | Background                                                                                  |
|      | Results  of Operations                                                                      |
|      | Fiscal  Year Ended November 30, 2002 Compared to Fiscal Year Ended November 30, 2001        |
|      | Fiscal  Year Ended November 30, 2001 Compared to Fiscal Year Ended November 30, 2000        |
|      | Backlog                                                                                     |
|      | Liquidity and Capital  Resources                                                            |
|      | Critical Accounting  Policies                                                               |
|      | Contractual  Obligations and Commercial Commitments                                         |
|      | Recently Issued  Accounting Standards                                                       |
|      |                                                                                        |
| Item  7a. | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 |
|      |                                                                                        |
| Item  8.  | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                |
|      |                                                                                        |
| Item  9.  | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE       |

 

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| Item  10. | DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT               |
|-----------|-------------------------------------------------------------------|
|      |                                                              |
| Item 11.  | EXECUTIVE  COMPENSATION                                           |
|      |                                                              |
| Item  12. | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT   |
|      |                                                              |
| Item  13. | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                   |
|      |                                                              |
| Item 14.  | CONTROLS AND  PROCEDURES                                          |
|      |                                                              |
| Item  15. | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K |

 

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*This report contains forward-lookingstatements within the meaning of the Private Securities Litigation Reform actof 1995.  The statements contained inthis report that are not historical in nature, particularly those that utilizeterminology such as “may,” “will,” “should,” “expects,” “anticipates,”“estimates,” “believes,” or “plans,” or comparable terminology, areforward-looking statements based on current expectations and assumptions.*

 

*Various risks and uncertaintiescould cause actual results to differ materially from those expressed inforward-looking statements.  These risksand uncertainties include our ability to consolidate operations and reducecosts; the continued demand for printed financial documents; our ability tooffset declining sales of our wired connectivity products; the success of themeasures we implemented to address inventory accounting controls; the marketacceptance of products incorporating wireless printing technologies; the impactof the delisting of our common stock from the Nasdaq National Market; ourability to hire and retain qualified management, technology and otherpersonnel; the impact of competition from existing and new technologies andcompanies; and the other factors set forth below under the heading “CertainImportant Factors” and in our other periodic reports and other documents thatwe file from time to time with the Securities and Exchange Commission*

 

We own or haverights to trademarks that we use in connection with the sale of ourproducts.  TROY®, *e*Check SecureTM, PrintraNetTM,TROYmarkTM,  StarACHTM, EtherwindTM,WindconnectTM, WindportTM, EtherSyncTM, Exact MICR TechnologyTM (ExMTTM) and ExactPositioning TechnologyTM (ExPTTM) are among the trademarks that we own.  This report also makes reference totrademarks and trade names of other companies.

 

**PART I**

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# **Item 1.  BUSINESS**

 

# **RecentDevelopments**

 

On November 5, 2002, TROY Group, Inc. announced that aSpecial Committee of the Board of Directors had been formed to consider aproposal by Patrick Dirk and his family members to purchase the interests ofthe minority stockholders of TROY.  Asof the filing of this report, the parties have not entered into a definitiveagreement regarding such acquisition.

 

## **General**

 

TROY Group, Inc.is a worldwide provider of enterprise output solutions.  For the past three years we have beenexpanding beyond our core business in digital check printing systems andrelated consumables by developing electronic payment systems and wired andwireless networking solutions.  Most ofthis new product expansion was accomplished through the acquisition and furtherinvestment in five small technology companies. These acquisitions have been organized under the two primary businesssegments:  Security Printing Solutions(previously TROY Systems) and Wireless and Connectivity Solutions (previouslyTROY Wireless).

 

Security PrintingSolutions provides state-of-the-art payment systems ranging from high securitydigital check printing systems to electronic payment and funds transfersolutions.  Our systems are used totransfer funds between bank accounts using paper checks or electronic ACH(Automated Clearing House) processes. Our products provide our customers with payment solutions that offersecurity, speed, flexibility and efficiency. Chase Manhattan, Citigroup, Del Monte Foods, Deutsche Bank, Federal 

 

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Express, Federal Reserve, Fidelity Investments, GMAC Commercial, HeinzUSA, Hewlett Packard, IBM, Maersk Line Ltd., Marsh USA, Monsanto, NCRCorporation, Progressive Insurance, Safeway Stores, Unisys, VISA USA, and Xeroxare among the TROY customers that purchased payment products during the last 12months.

 

Wireless andConnectivity Solutions provides hardware and software solutions that enableenterprises to share intelligent devices like printers either wirelessly orusing traditional networks.  We havebeen a supplier of hardwired network printing solutions since 1991.  Our wireless products include severaldevices which exchange information via *Bluetooth*TM and 802.11b short-range radioconnections.  Brother Industries, Ltd.,Seiko Epson Corporation and DaimlerChrysler AG are among the Wireless andConnectivity Solutions customers that have purchased these products during thelast 12 months.

 

We serve a widevariety of industries including financial services, insurance,telecommunications, computer hardware, automotive, personnel, government andothers.  We distribute our solutionsaround the world and market our products through a network of distributors andvalue-added resellers and a direct sales force.  More than 5,000 customers have purchased our products andservices during the last 12 months.

## ** **

## **Organization andDevelopment of Business**

 

TROY Group, Inc.is the result of various mergers and acquisitions by a company originallyfounded in 1982.  The founding Companyadopted the TROY Group name and incorporated in California in 1996 andreincorporated in Delaware in May 1998. Today, we are organized into two business segments: Security PrintingSolutions (previously TROY Systems) and Wireless and Connectivity Solutions(previously TROY Wireless).

 

In October 1998,we merged XCD Incorporated, a leading supplier of network connectivitysolutions, into our subsidiary TROY Wireless Company, formerly TROY XCD, Inc.  This subsidiary is now a part of Wirelessand Connectivity Solutions.

 

In May 1999, weacquired the remaining outstanding shares of Telgate Systems, Inc. (formerlyTelgate Equipment Corporation), a Canadian software development company.  This subsidiary is responsible for theongoing technical development and support for our electronic check and softwareproducts and is now a part of Security Printing Solutions.

 

In February, 2000,we acquired American Development (AMDev), Inc., an ACH (Automated ClearingHouse) software development and processing company.  TROY Financial Services, Inc.’s, formerly TROY AMDev, ACHproducts integrate with electronic checks to broaden our offering of e-commercepayment solutions.  This subsidiary isnow a part of Security Printing Solutions.

 

In May, 2000, weacquired CableNet Technologies, a North Carolina based company whichspecializes in printer enhancement and connectivity technology, enhancing ourtechnology platform to include IBM mainframe and midrange connectivity capabilities,as well as security and forms management products.  CableNet is now part of Wireless and Connectivity Solutions.

 

In May 2001, weacquired the hardware printing solutions operations of Extended SystemsIncorporated (“Extended Systems”), significantly enhancing our distributioncapabilities, technology portfolio and customer base in this area of ourbusiness.  This business line is now apart of Wireless and Connectivity Solutions.

 

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Our principalexecutive offices are located at 2331 South Pullman Street, Santa Ana,California 92705, and our telephone number at that location is (949) 250-3280.

 

Informationregarding our reportable business segments, major customers and geographicalinformation is contained in Note 13 to our financial statements on page F-21 ofthis report, and is incorporated in this item by reference.

## ** **

## **Products**

*** ***

***Security PrintingSolutions***

 

Security PrintingSolutions provides state-of-the-art payment systems ranging from high securitydigital check printing systems to electronic payment and funds transfersolutions.  Our systems are used totransfer funds between bank accounts using paper checks or electronic ACHprocesses.  Our products provide ourcustomers with payment solutions that offer security, speed, flexibility andefficiency.

 

Over the pastdecade there has been a dramatic shift from mainframe computer systems tonetworked computing environments.  Dueto this fundamental shift in the way corporations store and manage financialpayment data, IT departments are now faced with the challenge of providingusers with secure methods to make financial payments remotely and maintaincontrol over cash.  Security PrintingSolutions, through our MICR desktop check printing system, was the first todevelop a technology to effectively distribute payments electronically tomultiple end-users both within and outside an organization.

 

The emergence andadoption of enterprise-wide and web-based software applications is alsochanging the way organizations generate and securely distribute financialpayments.  Although many softwareapplications include basic financial reporting functionality, they generally donot adequately address an enterprise’s need to electronically transmit andoutput financial payments across networked computing environments or theWeb.  Security Printing Solutions isfocused on secure payment systems for back office processing as well as web,stand-alone or networked payment initiation.

 

We have beenexperts in the payment systems marketplace since 1971 and our experience hashelped make us a worldwide provider of secure financial payment systems.  Today, our services include a full array ofsecure payment solutions capable of addressing both print and electronic situations.  Security Printing Solutions’ products arenow organized into two product groups: Digital MICR Check Print Systems and related supplies and services, andFinancial Software and Services.

*** ***

***Digital MICR Check Printing Systems and Related Supplies andServices***

 

We begandeveloping MICR check printing systems in 1971 and today we are a worldwideprovider of MICR check printing systems and related supplies.  In 1984 we began installing secure paymentsystems for the U.S. Treasury that are still in operation today.   With the advent of laser technology andnetworking, we have expanded our products to serve the needs of virtually everybusiness that issues a check.

 

Today with ourtechnology, laser printers have the ability to print unique output such as theMICR line on the bottom of a check. MICR lines are printed with a magnetic ink or toner that, whenmagnetized, emits a magnetic signal that identifies each unique character.  If the shape and/or the magnetic propertiesof the characters do not meet specified standards, the banking system willreject the document, which could cause costly manual handling.  Our skill has been to develop printers andsupplies 

 

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that can print high-quality financial documents using blank paperstock.  Checks printed on our systemsconsistently exceed banking standards.

 

Our MICR checkprinting systems include hardware, firmware, software and imaging supplies thatprovide customers with functions not offered by most major OEMs (originalequipment manufacturers).  Ourtechnologies enable laser printers to print MICR lines, graphics, bar codes andforms.  They also enable a printer toperform other functions not offered by most printer manufacturers, such asauditing, status checking and security. These features increase an enterprise’s flexibility and customer servicecapabilities, eliminate costs associated with forms obsolescence and enhancedocument security.

 

Our strategicrelationship with Hewlett-Packard (“HP”) provides our customers with all of thebenefits of high-quality payment solutions combined with the features,functionality, and reliability provided by HP printers.  We offer various levels of high-quality MICRpayment solutions based on laser technology. Our laser solutions range in print speeds from 15 to 50 pages per minuteand combine laser-quality business documents with high-quality MICR coding.

 

Our most advancedprinting systems incorporate additional security features such asencryption/decryption, MICR sensors, password protection, key locks, and TROY’sexclusive special watermarking technology, TROYmarkä.  This high-quality line of MICR printers isideal for customers who require a more dedicated and fully secure financialpayment solution.

 

We have beencertified by the London-based Association for Payment Clearing Services (APACS)as complying with the organization’s standards for secure check printers.  APACS is a British banking organization thatsets the standards for check writing as well as all aspects of moneytransmission and payments-related activities in the United Kingdom.  The APACS standard is considered one of themost stringent in the world.

 

We also offer ourown proprietary MICR software solutions that streamline payment processes byprinting checks with security and ease on blank check stock.  Authorized finance, accounts payable andpayroll staff can merge accounting data with our software to create and printchecks securely and easily from different bank accounts, using multiple signatures,in a one-step process.  Our two primarycheck printing solutions are ChequeScribe I and ChequeScribe II.

 

•                  ChequeScribeI is a 32 bit Windows application used by banks, credit unions and savings& loan branches for on-demand new account check, cashier check, money orderor loan payment coupon printing.  WithChequeScribe I, customers have immediate access to personalized new accountchecks, custom loan coupons, and convenient bank payment products.

 

•                  ChequeScribeII Secure is a 32-bit check printing application compatible with Windows, UNIX,AS400 and mainframe-based accounting and payroll systems.  ChequeScribe II Secure enables our customersto print checks securely and easily from different bank accounts using multiplesignatures in a one-step process.  Thisinnovative solution streamlines check payment creation and prints checks onblank check paper with multi-layered security. It is capable of integrating with a wide array of commercial accountingapplications, including Great Plains, Peoplesoft, SAP, SunSystems, ACCPAC,Oracle and many more.

 

Laser paymentsolutions require imaging supplies on an ongoing basis.  We develop and market imaging supplies thatare uniquely formulated for specific output devices.  As new output devices are 

 

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developed, our chemical engineers combine their expertise with ouradvanced research and development equipment to design proprietaryformulations.  Our imaging supplies arethen produced in our sophisticated, computerized manufacturing facility.  We are recognized by our customers as ahigh-quality developer and manufacturer of proprietary imaging supplies.  TROY is one of the largest MICR tonermanufacturer in the USA and precision-manufactures the highest quality MICRtoner cartridges for laser printers.  Wealso offer other toners, ribbons and accessories for use with other than TROYprinting devices, and additional supplies which include fluorescent andindelible ribbons, post-encoding ribbons, jumbo rolls, standard toner, paperhandling accessories and check security paper. Approximately 50% of our revenue in fiscal 2002 came from our suppliesbusiness.

 

In addition, weoffer maintenance contracts to our customers on an annual, monthly and hourlybasis.  A major part of our maintenancework is subcontracted to third party vendors.

*** ***

***Financial Softwareand Services***

 

We have developedan expertise in electronic payment processing, primarily by Automated ClearingHouse (ACH) through the Federal Reserve. Our products and origination software and services all support thisgrowing financial settlement process, which is at the root of virtually everycommercial transaction.  According tothe National Automated Clearing House Association (NACHA), the nationalorganization of over 12,000 ACH system participants settle over six billionpayment transactions each year.  We havea product set that serves both bank and commercial customers.

 

Our software and services are:

 

•                  StarACH,which we launched in April 2001 at the NACHA payments conference, is our newestWindows-based ACH software product. StarACH is an enterprise-class, Internet-ready system capable ofhigh-speed processing.  It provides an alternativeto the legacy mainframe-based ACH systems that are still being used by mostbanks.

 

•                  VIPand NOVA are our Windows-based ACH software systems for small and mediumtransaction originators.  These systemssupport the requirements of financial institutions for in-house processing ofACH items.  These systems provide asimple, inexpensive solution to banks, credit unions and savings & loansupgrading from manual Fedline entry of ACH transactions.

 

•                  AutoDraftis our desktop ACH origination system for corporate users in networked orstandalone situations.  This softwaresystem provides a full array of ACH transaction types, simplified databaseentry and management as well as NACHA file formatting.  Batch transaction files are transmitted tothe bank or to our Nashville Data Center for TROY ACH processing.  AutoDraft is a flexible, inexpensivesolution to electronic payments, collections, payroll and other disbursements.

 

•                  *e*CheckSecureTM is our hosted online check service for web merchants and onlinebrokerage firms.  *e*Check Secure features aninteractive, real-time link with a leading check verification service for datavalidation.

 

•                  ACHtransaction processing services were provided in fiscal year 2002 through ourvarious banking relationships, but were discontinued in the first quarter offiscal year 2003.

 

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## ***Wireless and Connectivity Solutions***

 

Our Wireless andConnectivity Solutions business segment provides hardware and softwaresolutions that enable enterprises to share intelligent devices like printerseither wirelessly or using traditional networks.  Wireless and Connectivity Solutions has been a supplier ofhardwired network printing solutions since 1991.  Our wireless products allow a range of devices to exchangeinformation via *Bluetooth*TM and 802.11b short-range radio connections.  Wireless and Connectivity Solutions Productsare organized in two product groups: Connectivity Products and Wireless Products.

 

***Connectivity Products***

 

Our connectivityproducts support a number of protocols and network operating systems.  Although we have traditionally focused onprinter connectivity (print servers) for local area networks (LANs), ourproducts now enable devices to send and receive data and/or to be controlled,monitored, and diagnosed via a LAN and the Internet.

 

In May 2001, weacquired the printing solutions operations (print servers) of Extended Systems,in an effort to expand our distribution capabilities, technology portfolio andcustomer base.  We are currentlymarketing these products under the TROY ExtendNet brand.

 

Our connectivityproducts include:

 

•                  XJet.The XJet Ethernet and Fast Ethernet print servers plug into the internal slotof Hewlett-Packard LaserJet® printers.

 

•                  Pony, Xconnect,PocketPro, and ExtendNet.These print servers support 1, 2, or 4 printers and work onEthernet  and/or Fast Ethernet networks.

 

•                  Serial Server.The Serial Server connects a wide range of devices, such as medicalinstrumentation, numerical control equipment, LED signs, and much more toEthernet networks.

 

•                  SoftPrint Server.The Soft Print Server is a software solution that can be integrated into ourcustomer’s product and provides the same benefits as exist in our hardwaresolutions.

 

•                  OEMproducts.TROY develops custom hardware products for OEM applications.

 

•                  SpecialtyProducts.TROY also offers products for security, barcode, electronic forms,non-networked printer sharing, and other applications.

 

***Wireless Products***

 

Over the pastseveral years, there has been increased adoption of various mobile computingtechnologies.  As a result, computerusers are now faced with the challenge of outputting data from mobile devicesthrough stationary PC/peripheral configurations and/or local area networks(“LANs”) that are not specifically configured to interoperate with the mobiledata sources.  In this new age of mobile

 

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information, there is a growing need for intelligent devices such asPC’s, cellular telephones, Personal Digital Assistants (PDA’s), printers, anddigital cameras to exchange information with each other.

 

We provide a rangeof products that enable users of these new devices to print information overwireless networks without the need to install device-specific driversoftware.  Our wireless products arehardware and software solutions that address both 802.11b and *Bluetooth*,which are the two emerging industry standards for short-distance wirelesscommunications within a single building.

 

Our current802.11b Products include:

 

•                  EtherWindTMWireless Print Server.Our EtherWind Print Server features support for networking protocol standards,and has interoperability with most printers, operating systems, and other802.11b products (e.g. PCMCIA cards and access points).

 

•                  EtherSyncTMPC Wireless Card.Our EtherSync PC Card works with most laptop computers to deliver wirelessnetwork access and the freedom to print from anywhere within our customer’shome or office.

 

•                  EtherPortalTMWireless Access Point.Our EtherPortal Access Point combines a wireless access point, router,firewall, 4-port switch, and print server into one low-cost device.

 

•                  OEMModulesOur OEM modules provide custom embedded solutions to our customer’sapplications, from middleware/firmware to turnkey hardware/firmware solutions.

 

*Bluetooth* is alow-cost wireless technology that is especially useful for enabling small,battery-powered mobile devices like cellular telephones to communicate withother mobile or fixed devices at distances up to 10 meters (33.7 feet).

 

Our current *Bluetooth*products include:

 

•                  WindConnectTMPrint Adapter which can be attached to most printers enabling them to receivedata without wires or cables and print from PCs, laptops, PDA’s and cellularphones.

 

•                  OEMModules which provide custom embedded solutions to our customer’s applications,from middleware/firmware to turnkey hardware/firmware solutions.

 

## **Business Strategies**

 

Our objective isto return the Company to profitability and to expand our market share as aprovider of enterprise output solutions. Our strategies for achieving this objective include:

* *

*Continung to search for costreduction opportunities.*In addition to reviewing alloperations for cost reduction opportunities, we expect to install a new ERP(enterprise resource planning) system by the end of this fiscal year. We expectthis system to improve operational efficiencies and work flows, eliminateseveral manual systems, improve customer service and reduce cost.

 

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*Evaluating the performance ofbusiness segments and product lines.*We will continue toreview the performance of our business segments and product lines to determineif we will invest, maintain or discontinue those operations.  We evaluate business performance based onprofitability, competitive advantage in the market and growth potential.

* *

*Introducing and Enhancing Productsthrough Research and Development*.  We achieved a leadership position in MICR check printing byinvesting in research and development, introducing higher-quality products andfocusing on satisfying the needs of both our OEM customers and end users.  We continue to invest in research anddevelopment to enhance our current technologies and introduce new products.

* *

*Leveraging Strategic Alliances*.  We currently partner with various software,firmware, hardware and financial service companies in offering solutions thatassist us in meeting our customers’ needs. We intend to continue to aggressively pursue new strategic alliancesthat we believe will enable us to enter new markets, expand our distributionchannels and enhance our product and service offerings.  We currently have management resourcesdedicated to developing strategic alliances.

* *

*Expanding Distribution Channels*.  We believe that by expanding both our U.S.and International distribution channels we can increase revenues for most ofour MICR check printing products.  Wehave expanded our distribution sales force and are actively recruitingdistributors, dealers and VARs (Value Added Resellers) both domestically andinternationally.

 

There can be noassurance that we will be successful in pursuing these business strategies,which necessarily involve certain risks (see “Certain Important Factors” aspresented on pages 12 to 16).

 

## **Research andProduct Development**

 

We are committedto growing our business through research and development, and it is one of ourmajor business strategies.  We seekcustomer feedback in the product design process in order to meet changingrequirements, and are committed to developing functional and integratedsolutions in a rapid and efficient manner. As of February 28, 2003, we employed approximately 29 persons in ourresearch and development efforts.  Ourhighly trained staff of software, electrical, mechanical and chemical engineersis focusing on principal research and development activities such as:

 

•                  developingsecure printing solutions;

 

•                  creatingproprietary imaging supplies;

 

•                  developingsoftware and firmware for Wireless and Connectivity products;

 

•                  developingnew products that provide solutions for our strategic business partners; and

 

•                  developingelectronic payment solutions.

 

## **Support Services**

 

We offer technicalsupport, maintenance and on-site services, portions of which are provided bythird parties.  We provide technicalsupport through a toll-free telephone line from 7:00 AM to 5:00 PM (PST) andthrough our web site.  We also provideon-site service through yearly maintenance contracts or on a time-and-materialsbasis.

 

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In addition to ourtechnical support, maintenance and on-site services, we have maintained the *MICRTechnology Center*, a research group dedicated to providing solutionsfor MICR document processing problems. Members of the testing facility for this research group have the abilityto examine all aspects of the MICR printing process to pinpoint whereimprovements can be made and to ensure the highest-quality MICR line.

 

## **Sales and Marketing**

 

Our two businesssegments, Security Printing Solutions and Wireless and Connectivity Solutionshave independent sales and marketing organizations.  They focus on their respective product groups.  They are similar in that they marketproducts to Fortune 1000 companies through a direct sales force, and to smalland mid-size businesses primarily through a network of distributors andvalue-added resellers.  Our products arerepresented internationally, primarily through a distributor network.

 

Our SecurityPrinting Solutions segment markets check printing solutions to financialservices, insurance, telecommunications, computer hardware, automotive,personnel, government and others.  Ourbase of more than 5,000 active customers includes  many Fortune 1000 companies and the U.S. Treasury.  Chase Manhattan, Citigroup, Del Monte Foods,Deutsche Bank, Federal Express, Federal Reserve, Fidelity Investments, GMACCommercial, Heinz USA, Hewlett Packard, IBM, Maersk Line Ltd., Marsh USA,Monsanto, NCR Corporation, Progressive Insurance, Safeway Stores, Unisys, VISAUSA, and Xerox are among the TROY customers that purchased payment productsduring the last 12 months.

 

We sell ourWireless and Connectivity Solutions through OEM partners, value-addedresellers, distributors and directly to corporations.  Our OEM customers include companies such as OKI, Monarch, Zebra,Texas Instruments, Epson, Brother, Eastman Kodak, Encad, and Hitachi Koki.  We have co-marketing arrangements with SonyEurope, Compaq, and Kyocera.  Throughour German sales team, we sell directly to major corporations such as DaimlerChrysler and Siemens.

 

We have increasedthe number of sales and support staff dedicated to recruiting and trainingadditional distributors and value-added resellers.  This supports our strategy to sharpen our focus on mid-size andsmaller companies that will increasingly use networks to facilitate theirbusiness needs.  We also have managementresources dedicated to recruiting and developing new OEM relationships andleveraging strategic alliances in support of our key business strategies.

 

We promote ourproducts through our web site, trade shows, advertising and direct marketingmaterials as well as referrals from our strategic business partners, includingTexas Instruments, Atmel, Intersil Corporation, HP, IBM, and Standard Register.

 

## **StrategicRelationships**

 

In fiscal year 2002, TROY continued to establish andenhance relationships with key industry and technology partners.

 

The digital checkprinter market continues to be an important part of our business, and we arecontinuing to develop new products to address the needs of the market.  Since 1993, we have also maintained astrategic relationship with Hewlett-Packard’s various printing groups.  In addition, we are a member ofHewlett-Packard’s LaserJet Integrated Solutions Partner Support Program (ISPS),a select group of third-party solutions partners.  As a member of this group, we work with Hewlett-Packard onarchitecture issues for new product development.  We believe that our relationship with Hewlett-Packard gives us acompetitive advantage in marketing our products, primarily because of HP’sreputation as the leading provider of laser printers throughout the world.

 

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We have a jointmarketing relationship with IBM, the world leader in the development andmanufacture of advanced information technology.  In an agreement with TROY, IBM has agreed to purchase from us allof its MICR toner requirements for the IBM 3900, InfoPrint 4000, and thesoon-to-be-released IBM 4100 family of high-speed laser printers.

 

We are an OEMsupplier to Standard Register.  StandardRegister is a recognized leader in delivering document management systems,products and services to healthcare, financial and general business markets.  We private-label MICR and multi-purposeprinters for Standard Register, to be used in conjunction with their variousdocument management solutions including LINKUPTM, a check printing softwaresystem, and PATIENT LINKUPTM, a hospital admissions and document routing system.

 

During 2002 we continued to ship our EtherWind 802.11bprint server to Epson as part of an OEM agreement in which the EtherWind isbundled with the Epson Stylus C80 inkjet printer. We continued to enhance theEtherWind by taking advantage of our technology partnership with the IntersilCorporation as a part of the PRISM Partnership Initiative program. We haveexchanged technology with Kyocera Wireless utilizing our WindConnect BluetoothPrinter Adapter and their new 7135 Smart Phone and this has led to aco-marketing agreement.  We have alsosigned an alliance agreement with Kyocera-Mita printing and copying divisionthat joint markets our WindConnect Bluetooth Printer Adapter and our EtherWind802.11B Printer adapter. This has led to signing reseller agreements with manyKyocera-Mita dealers. We continued to be a partner with Texas Instruments byadapting our Bluetooth Protocol Stack to support the DSP family of processors.

 

## **Competition**

 

The market for ourproducts is highly competitive and subject to rapid technological change.  We compete principally on the basis of thequality, flexibility, convenience and security of our enterprise outputsolutions.  Overall, we believe that weare well positioned in our industry and compete favorably as a result of:

 

•                  ourhighly trained team of software, firmware, electrical, mechanical and chemicalengineers and programmers;

 

•                  ourcommitment to understanding the changing needs of our marketplace;

 

•                  ourability to develop new solutions to meet those needs;

 

•                  thebreadth of our products’ features;

 

•                  ourreputation for knowledge, technical expertise and professionalism;

 

•                  thestrength and scope of our strategic relationships;

 

•                  ourcapable and reliable technical support capabilities; and

 

•                  ahistorical and ongoing commitment to quality.

 

** **

**Security Printing Solutions**

* *

*MICR Check printing solutions.* Our primary competitors in networked computerpayment solutions are Source Technologies, Xerox, ACOM Solutions, andRosetta.  We believe that our current 

 

10

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relationship with Hewlett-Packard gives us a competitive advantage inthe MICR printing market, primarily because of Hewlett-Packard’s reputation asthe leading provider of laser printers worldwide.

* *

*Imaging Supplies*.  We compete in the specialty toner and ribbonmarket primarily on the basis of quality and service.  Color Image is our most significant competitor with respect toour toner products.  Our significantcompetitors with respect to ribbons are Nu-Kote International, Fuji CopianCorporation and Columbia.  We positionourselves as a full-service provider, with a pricing strategy that reflects ourquality, reliability, precision of formulation and available customersupport.  We believe we have been ableto maintain a leadership position in the MICR printer and imaging suppliesbusiness as a result of advanced technological features (including security),higher levels of quality and value-added services.

* *

*F**inancialSoftware & Services Solutions.* We develop, market and support a variety of software systems.  Our key competitors are CheckFree, andPolitzer & Haney for ACH processing systems.  We believe our software systems have unique features thatcompetitively differentiate them from other providers.  We continue to develop enhancements to ourcore software systems that, we believe, will continue to provide uniquecapabilities to our software users.

 

We are anauthorized reseller of Certegy check verification services, formerly EquifaxCheck Services.  Certegy also has otherauthorized resellers, such as BankServ, Xign and Intellicheck, which providecompetitive service offerings.  *e*CheckSecure provides secure online checks and competes with Authorize.net, DeluxeCheck, PaybyCheck, and a host of other online check service providers.  TROY differentiates itself in real-timeverification, coupling a flexible front end with back-office reporting.

** **

**Wireless and Connectivity Solutions**

* *

*Wireless Solutions*.  The *Bluetooth* and 802.11b wireless markets areemerging markets.  Our primarycompetitors in the *Bluetooth* market are MPI, AnyCom and AxisCommunications.  In addition, HP, NECand Samsung have delivered *Bluetooth* capabilities on their lines ofprinters.  Our competitors in the802.11b printer connectivity market are HP, Buffalo, Linksys, D-Link, Sercomm,and Komatsu.  Competitors with ourexpanded 802.11b product line beyond the print server include Cisco, Agere,3Com, Linksys, D-Link, SMC, Proxim, Symbol, and others.  Our primary competitors in the *Bluetooth*****softwareprotocol stack market are Extended Systems Inc. and Widcomm Inc.  Other competitors include IVT Corporation,Stonestreet One, Inc., and several other smaller companies.

* *

*Connectivity Solutions*.  In the print server market, HP, Intel, Axis,S.E.H., J.C.I., Lantronix, Lexmark and MiLAN offer competing products that aresuitable for multiprotocol enterprise network printing applications.  There are many other commodity printservers, including very low-cost products, but such commodity print servers arenot usually suitable for enterprise networks due to inadequate protocol supportand features, limited customer support and low performance.  In addition, our support of both PrintraNetand IPP Internet connectivity provides another advantage over most of ourcompetitors.  Although Hewlett-Packardmakes print servers, we do not generally consider them a directcompetitor.  This is because we are aHewlett-Packard partner providing DEC and Banyan VINES connectivity solutionsthat are not available on Hewlett-Packard products.

 

## **Intellectual Property**

 

We have certainproprietary printing system components, manufacturing processes, information,knowledge, trademarks and tradenames. We rely on a combination of patent, trademark, trade secret and otherintellectual property laws, nondisclosure agreements with employees andinternal confidentiality measures to protect our intellectual property rightsand confidential information.  We seekpatents from time to time on products and processes.  The decision to seek additional patents is based on analysis of 

 

11

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various business considerations such as the cost of obtaining a patent,the likely scope of patent protection and the benefits of patent protectionrelative to relying on trade secrets protection and other measures.  We also rely on specialized know-how andcontinuing technological innovation to develop and maintain our competitiveposition.

 

As of February 28,2003, we held ten United States patents. Our existing patents primarily cover components of our impact printingsystems and proprietary consumables. There can be no assurance that our issued patents will providemeaningful protection of our products and technologies.  In addition, patent applications can bedenied or significantly reduced before issuance.  Moreover, there can be no assurance that third parties will notassert intellectual property infringement claims against us or that, if suchclaims are asserted, we would prevail or be able to obtain any necessarylicenses.

 

We believe thatour proprietary manufacturing processes and techniques, materials expertise andtrade secrets may provide us with a competitive advantage as important as, ifnot more important than, patent protection. We seek to maintain the confidentiality of this proprietary informationby requiring employees who have access to proprietary information to signconfidentiality agreements and by limiting its disclosure to outsideparties.  There can be no assurance,however, that these measures will provide us with adequate protection of our proprietaryinformation or with adequate remedies in the event of unauthorized use ordisclosure.  In addition, there can beno assurance that our competitors will not independently develop or otherwisegain access to processes, techniques or trade secrets that are similar orsuperior to ours.  Finally, as withpatent rights, legal action to enforce trade secret rights can be lengthy andcostly, with no guarantee of success.

 

## **Environmental andRegulatory Matters**

 

Our MICR printerand imaging supplies manufacturing operations are subject to numerous domesticand international laws and regulations, particularly relating to environmentalmatters that impose limitations on the discharge of pollutants into the air,water and soil and establish standards for the treatment, storage and disposalof solid and hazardous wastes.  We arealso required to have permits from a number of governmental agencies in orderto conduct various aspects of our business. Compliance with these laws and regulations is not expected to have amaterial adverse effect on our capital expenditures, earnings or competitiveposition.  There can be no assurance,however, that future changes in environmental laws or regulations, or in thecriteria required to obtain or maintain necessary permits, will not have amaterial adverse effect on our operations.

 

## **Employees**

 

As of February 28,2003, we employed approximately 215 persons. None of our employees are represented by a labor union or covered by acollective bargaining agreement.  We havenot experienced any work stoppages and consider relations with our employees tobe good.

 

# **Item 1A.  CERTAIN IMPORTANT FACTORS**

 

There are several important factors that could causeour actual results to differ materially from those we anticipate or thosereflected in any of our forward-looking statements.  These factors, and their impact on the success of our operationsand our ability to achieve our goals, include those set forth below.

** **

**We maynot be able to reduce costs sufficiently to return to profitability.**

 

We have addedsignificant costs due to acquisitions in recent years. In 2002, we implementeda turnaround plan to consolidate operations and reduce costs.  While some facilities have been consolidated

 

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and some costs have been reduced, there is no assurance that we will beable to reduce costs sufficiently to return to profitability in 2003 or at all.

 

**Ourbusiness depends on the continued demand for printed documents, includingfinancial documents.**

 

Because we providesolutions that allow enterprises to distribute and print information, ourbusiness depends on the continued demand for printed documents.  Demand for these solutions could decline ifbusinesses and organizations move toward “paperless” environments and reducetheir dependence on printed documents. Demand for printed financial documents may be reduced as a result ofcompetition from alternate financial document delivery or payment methods, suchas electronic banking, electronic commerce, on-line services and otherelectronic media.  We cannot assure youthat changes in the business environment or competition from alternatefinancial document delivery or payment methods will not significantly erode thedemand for our products and cause our business to suffer.

** **

**Weexpect that sales of our wired connectivity products will decline, and there isno assurance that we will be able to offset this decline through reduced costsor increased sales of other products.**

 

We anticipate thatsales of our wired connectivity products, which constitute a significantportion of our overall sales of Wireless and Connectivity Solutions, willdecline as these products are at or approaching end of life.  In order to return to profitability, it willbe necessary for us to offset this decline in sales of wired connectivityproducts through reduced costs or increased sales of other products, and thereis no assurance that we will be successful in achieving such reduced costs orincreased sales.

** **

**There isno assurance that the measures we have implemented to address weaknesses in ourinventory accounting controls will be sufficient.**

 

On October 15,2002, we issued a press release announcing that the filing of our Form 10-Q forthe fiscal quarter ended August 31, 2002 would be delayed.  We had conducted physical inventory countsand discovered certain inventory adjustments. As a result, we reviewed our inventory accounting controls, anddetermined that there were certain material weaknesses.  Since that time, we have implemented anumber of corrective measures to address these weaknesses. However, there is noassurance that these measures will be successful.

** **

**Ourshares have been delisted from the Nasdaq National Market, which has resultedin less liquidity for stockholders, and there is no assurance that our shareswill again be eligible for listing.**

 

Our shares weredelisted from trading on the Nasdaq National Market on December 31, 2002because we were not able to timely file our quarterly report on Form 10-Q forthe third quarter of fiscal 2002.  Sincethat time, our shares have traded in the Pink Sheets over-the-counter market,which results in lower trading volume and less liquidity for stockholders.  We cannot assure you that our shares will beeligible for listing on the Nasdaq National Market or the Nasdaq SmallCapMarket in the future or, if eligible, that we will apply for such listing.

** **

**Thesuccess of our wireless initiatives depends on our ability to develop andintroduce on a timely basis new products for existing and emerging wirelesscommunications markets and the ability of these products to gain marketacceptance.**

 

The development ofnew wireless networking products is highly complex, and we may experiencedelays in developing and introducing new products on a timely basis.  Due to the intensely competitive nature ofthe wireless market, any delay in the commercial availability of new productscould 

 

13

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materially and adversely affect our business.  In addition, if we are unable to develop or obtain access toemerging wireless networking technologies as they become available, or areunable to design, develop and introduce on a timely basis products based onthese emerging technologies, our future operating results would be materiallyand adversely affected.  To date, ourwireless solutions have not gained market acceptance or had any meaningfulcommercial impact, and there can be no assurance that our wireless solutionswill ever gain market acceptance or have a commercial impact.  In addition, there can be no assurance thatour wireless products will be based on the wireless standards that areultimately adopted by the marketplace.

 

**Technologyin our industry evolves rapidly, and we must continue to enhance existingproducts and develop new products or our business will suffer.**

 

Rapidtechnological advances, obsolescence and large fluctuations in demand andchanging industry standards characterize the markets for our currentproducts.  Our existing anddevelopment-stage products may easily become obsolete if our competitorsintroduce newer or better technologies or if industry standards change.  To be successful, we must continuallyenhance our existing products and develop and introduce other MICR checkprinting and wireless and other connectivity products.  If we fail to adequately anticipate orrespond to changing technological developments and standards or customerrequirements, or if we are significantly delayed in developing and introducingproducts, our business will suffer.  Inaddition, our success in this rapidly changing environment depends on ourability to appropriately refocus our management attention and other resourceson the emerging technologies and standards that will ultimately gain marketacceptance.

** **

**We face significant competition thatmay negatively impact our revenues, gross margins and market share.**

 

We face increasedcompetition in developing and selling digital MICR check printing solutions aswell as our wireless and connectivity solutions.  Many of our competitors in this market have substantially greaterfinancial, development, marketing and personnel resources than we have.  We cannot assure you that we will be able tocompete successfully against our current or future competitors.  Increased competition may result in pricereductions, lower gross margins and loss of market share.

** **

**We maintain strategic supply, OEM andmarketing arrangements, and termination of these relationships could adverselyaffect our revenues and earnings.**

 

We maintain anddepend on strategic relationships with a number of companies, includingCertegy, Hewlett-Packard, IBM, Novell, Standard Register and Wind River.  These relationships include supply, OEM,marketing and service arrangements which are important to our business.  Certain of these relationships are notcovered by written agreements and could be terminated at any time.  If our relationship with any of thesecompanies were to end, our revenues and earnings could fall.  We cannot assure you that we will be able tomaintain our strategic relationships with these companies.

** **

**We sell a significant portion of ourproducts internationally, which exposes us to currency fluctuations and otherrisks.**

 

We sell asignificant amount of our products to customers outside the United States.  International sales accounted for 17.0% ofour net sales in the year ended November 30, 2002.  International sales represented 14.9% of our net sales in thefiscal year ended November 30, 2001, and 13.7% of sales in the fiscal year endedNovember 30, 2000.  We expect thatshipments to international customers will continue to account for a materialportion of our net sales.  Sales outsidethe United States involve the following risks, among others:

 

14

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•                  foreigngovernments may impose tariffs, quotas and taxes;

 

•                  politicaland economic instability may reduce demand for our products;

 

•                  restrictionson the export or import of technology may reduce or eliminate our ability tosell in certain markets; and

 

•                  potentiallylimited intellectual property protection may cause us to refrain from sellingin certain markets.

 

Because wedenominate some of our international sales in U.S. dollars, currencyfluctuations could also cause our products to become less affordable or lessprice-competitive than those of foreign manufacturers.  We cannot assure you that these factors willnot have a material adverse effect on our international sales.  Any adverse impact on our internationalsales would affect our results of operations and would cause our business tosuffer.

 

**Ourquarterly operating results fluctuate as a result of many factors.**

 

Our quarterlyoperating results fluctuate due to various factors.  Some of the factors that influence our quarterly operatingresults include:

 

•                  themix of products and services sold in the quarter;

 

•                  life-cyclestages of the products sold in the quarter;

 

•                  theavailability and cost of components and materials;

 

•                  costsand benefits of new product and service introductions; and

 

•                  customerorder and shipment timing.

 

Because of thesefactors, our quarterly operating results are difficult to predict and arelikely to vary in the future.  If ourearnings are below expectations in any quarter, our stock price is likely to drop.

 

**We may not be able to adequatelyprotect or enforce our intellectual property rights or to protect ourselvesagainst infringement claims of others.**

 

We cannot becertain that the steps we have taken to protect our intellectual propertyrights will be adequate or that third parties will not infringe ormisappropriate our proprietary rights. Any such infringement or misappropriation could have a material adverseeffect on our future financial results. We also cannot be certain that we have not infringed the proprietaryrights of others.  Any such infringementcould cause third parties to bring claims against us, resulting in significantcosts, possible damages and substantial uncertainty.

 

**We depend on our executive officersfor our success.**

 

We are significantlydependent upon Patrick J. Dirk, our Chairman and Chief Executive Officer, andour other executive officers.  Therecould be a material adverse effect on our business if we lose the services ofMr. Dirk or any other executive officer.

 

15

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**Compliance with governmentregulations may cause us to incur unforeseen expenses.**

 

Our MICR printerand imaging supplies manufacturing operations are subject to a number offederal, state and local laws and regulations. These regulations include laws and regulations promulgated by theEnvironmental Protection Agency and similar state agencies regarding storing,shipping, disposing, discharging and manufacturing hazardous materials andhazardous and non-hazardous waste. Although we believe that our operations materially comply with allcurrent laws and regulations, we cannot assure you that these regulations willnot change.  We also cannot assure youthat unforeseen environmental incidents will not occur, or that pastcontamination or non-compliance with environmental laws will not be discoveredon our current or former properties. Any of these events could result in significant expense or requirechanges in our operations, which could materially and adversely affect ourbusiness.

 

**Our former status as an S corporation could expose us toliability.**

 

From December 1989to October 30, 1998, TROY Group and TROY Systems elected S corporation statusunder the Internal Revenue Code. Although we believe that TROY Group and TROY Systems met the Scorporation requirements under the Code during this period, the IRS has notchallenged or made a determination as to our status.  If the IRS determines that TROY Group or TROY Systems did notmeet the Code requirements for S corporations, we could be liable for unpaidfederal and state income taxes for all or a part of the time that we elected Scorporation status, plus interest and possible penalties.

 

# **Item 2.  PROPERTIES**

 

We currently leaseapproximately 37,000 square feet of space for our headquarters in Santa Ana,California.  Our other facilities arelocated in Wheeling, West Virginia, where we lease approximately 77,000 squarefeet for a manufacturing facility; in Nashville, Tennessee, where we leaseapproximately 5,300 square feet; in Boise, Idaho, where we lease 1,500 squarefeet; in Coquitlam, British Columbia, where we lease approximately 7,000 squarefeet; and in Herrenberg, Germany, where we lease 6,000 square feet.  We consider our present facilities to besufficient for our current operations.

 

# **Item 3.  LEGAL PROCEEDINGS**

 

On November 21,2002, Tom Lloyd filed an action in the Superior Court of the State ofCalifornia in and for Orange County against TROY and its directors, allegingthat defendants breached their fiduciary duties by attempting to provide theDirk family with preferential treatment in connection with their efforts tocomplete a sale of the company. The complaint seeks to enjoin an acquisition ofTROY by the Dirk family, as well as attorneys’ fees. We believe that ourcompany and the individual defendants have meritorious defenses in the Lloydaction, and intend to continue to defend this lawsuit vigorously. If thislitigation is resolved in favor of the plaintiffs, however, it could have amaterial adverse effect on TROY and its stockholders.

 

# **Item 4.  SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

No matter wassubmitted for a vote of our security holders during the fourth quarter of thefiscal year covered by this report.

 

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**PART II**

 

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# **Item 5.**           MARKET FOR REGISTRANT’S COMMON EQUITY ANDRELATED STOCKHOLDER MATTERS.

 

**Common Stock Information**

 

Our common stockis currently trading on the National Quotation Bureau, commonly referred to asthe “Pink Sheets” under the symbol “TROY.PK.” Our common stock traded on the Nasdaq National Market from July 21, 1999until December 31, 2002.  The followingtable sets forth, for each of the fiscal periods indicated, the range of highand low sale prices per share as reported by the Nasdaq National Market.  These prices do not include adjustments forretail mark-ups, mark-downs or commissions.

 
| **Fiscal  2002** |   | **High** |   | **Low** |   |
|------------------|--------|----------|--------|---------|--------|
| First Quarter    |   | $        | 4.44   |    | $      | 3.35 |   |
| Second Quarter   |   | $        | 4.55   |    | $      | 3.50 |   |
| Third Quarter    |   | $        | 4.25   |    | $      | 1.88 |   |
| Fourth Quarter   |   | $        | 2.43   |    | $      | 0.93 |   |

 
| **Fiscal  2001** |   | **High** |   | **Low** |   |
|------------------|--------|----------|--------|---------|--------|
| First Quarter    |   | $        | 8.56   |    | $      | 3.81 |   |
| Second Quarter   |   | $        | 4.84   |    | $      | 2.81 |   |
| Third Quarter    |   | $        | 6.25   |    | $      | 4.00 |   |
| Fourth Quarter   |   | $        | 4.80   |    | $      | 3.25 |   |

 

We have notdeclared or paid any cash dividends (other than S corporation distributions) onour common stock since our inception, and the Board of Directors presentlyintends to retain all earnings for use in our business for the foreseeablefuture.  In addition, our ability todeclare and pay dividends is restricted by the terms of certain of our debtagreements.  See Note 7 to our financialstatements on page F-14 of this report.

 

As of February 28,2003, there were approximately 125****record holders of our common stock.

 

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# **Item 6.  SELECTED FINANCIAL DATA.**

 

**Summary Statements of OperationsData:**

**(in thousands, except per share data)**

** **
| **For the year ended November 30:**          |   | **1998** |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|----------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Net sales                                    |   | $        | 35,758 |     | $      | 59,121   |   | $        | 52,310 |     | $      | 49,218 |   | $ | 54,998 |   |
| Gross profit                                 |   | 14,262   |   | 22,531   |   | 22,257   |   | 18,452   |   | 16,987   |   |
| Net income  (loss)                           |   | 4,434    |   | 5,827    |   | 2,407    |   | (5,945   | )      | (3,175   | )      |
|                                         |   |     |   |     |   |     |   |     |   |     |   |
| Pro forma net  income                        |   | 2,371    |   | —   |   | —   |   | —   |   | —   |   |
|                                         |   |     |   |     |   |     |   |     |   |     |   |
| Basic net income  (loss) per share           |   | $        | 0.32   |     | $      | 0.67     |   | $        | 0.22   |     | $      | (0.55 | ) | $ | (0.30 | ) |
|                                         |   |     |   |     |   |     |   |     |   |     |   |
| Diluted net  income (loss) per share         |   | $        | 0.31   |     | $      | 0.64     |   | $        | 0.21   |     | $      | (0.55 | ) | $ | (0.30 | ) |
|                                         |   |     |   |     |   |     |   |     |   |     |   |
| Weighted average  diluted shares outstanding |   | 7,745    |   | 9,116    |   | 11,369   |   | 10,775   |   | 10,647   |   |

 

**Summary Balance Sheet Data:**

**(in thousands)**

** **
| **At November 30:**                      |   | **1998** |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Working capital                          |   | $        | 5,806  |     | $      | 25,011   |   | $        | 24,903 |     | $      | 21,170 |   | $ | 19,317 |   |
|                                     |   |     |   |     |   |     |   |     |   |     |   |
| Total assets                             |   | 18,918   |   | 37,058   |   | 42,575   |   | 37,007   |   | 33,539   |   |
|                                     |   |     |   |     |   |     |   |     |   |     |   |
| Long-term debt  (net of current portion) |   | 3,333    |   | 331      |   | 272      |   | 193      |   | 120      |   |
|                                     |   |     |   |     |   |     |   |     |   |     |   |
| Stockholders’  equity               |   | 8,265    |   | 29,795   |   | 35,615   |   | 28,732   |   | 25,626   |   |
|                                          |        |          |        |          |        |          |        |          |        |          |        |  |  |  |  |  |

 

The aboveinformation includes our initial public offering on July 21, 1999 and ouracquisitions of XCD Incorporated in October 1998, Telgate Systems in May 1999,American Development (AMDev), Inc. in February 2000, CableNet Technologies inMay 2000 and the printing solutions operations of Extended Systems Incorporatedin May 2001.  See Note 2 to our financialstatements on page F-12 of this report for further information includinginformation regarding pro forma net income.

 

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# **Item 7.**          MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The followingdiscussion and analysis should be read in conjunction with our ConsolidatedFinancial Statements and related Notes included in this report.

 

## **Background**

 

TROY Group, Inc.is a worldwide provider of enterprise output solutions.  For the past three years we have beenexpanding beyond our core business in digital check printing systems andrelated consumables by developing electronic payment systems and wired andwireless networking solutions.  Most ofthis new product expansion was accomplished through the acquisition and furtherinvestment in five small technology companies. These acquisitions have been organized under our two primary businesssegments:  Security Printing Solutions(previously TROY Systems) and Wireless and Connectivity Solutions (previouslyTROY Wireless).

 

Security PrintingSolutions provides state-of-the-art payment systems ranging from high securitydigital check printing systems to electronic payment and funds transfersolutions.  Our systems are used totransfer funds between bank accounts using paper checks or electronic ACH(Automated Clearing House) processes. Our products provide our customers with payment solutions that offersecurity, speed, flexibility and efficiency. Chase Manhattan, Citigroup, Del Monte Foods, Deutsche Bank, Federal Express,Federal Reserve, Fidelity Investments, GMAC Commercial, Heinz USA, HewlettPackard, IBM, Maersk Line Ltd., Marsh USA, Monsanto, NCR Corporation,Progressive Insurance, Safeway Stores, Unisys, VISA USA, and Xerox are amongthe TROY customers that purchased payment products during the last 12 months.

 

Wireless andConnectivity Solutions provides hardware and software solutions that enableenterprises to share intelligent devices like printers either wirelessly orusing traditional networks.  Our wirelessproducts include several devices which exchange information via *Bluetooth*TMand 802.11b short-range radio connections. Brother Industries, Ltd., Seiko Epson Corporation and DaimlerChrysler AGare among the TROY Wireless customers that have purchased these products duringthe last 12 months.

 

We serve a widevariety of industries including financial services, insurance,telecommunications, computer hardware, automotive, personnel, government andothers.  We distribute our solutionsaround the world and market our products through a direct sales force and anetwork of distributors and value-added resellers.  More than 5,000 customers have purchased our products andservices during the last 12 months.

 

In fiscal years2000, 2001, and 2002 there were no customers who accounted for 10% of theCompany’s net sales.

 

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## **Results of Operations**

 

The followingtable sets forth, for the periods indicated, certain information derived fromour consolidated statements of operations expressed as a percentage of netsales:

 
|                                          |   |   |   | **Fiscal  Year Ended  November 30,** |   |
|-----------------------------------------------|--------|--------|--------|--------------------------------------|--------|
|                                          |   |   |   | **2000**                             |   | **2001** |   | **2002** |   |
| Net sales                                     |   |   |   | 100.0                                | %      | 100.0 | % | 100.0 | % |
| Cost of goods  sold                           |   |   |   | 57.5                                 |   | 62.5 |   | 69.1 |   |
| Gross Profit                                  |   |   |   | 42.5                                 |   | 37.5 |   | 30.9 |   |
| Selling, general  and administrative expenses |   |   |   | 27.1                                 |   | 31.9 |   | 27.1 |   |
| Research and  development expenses            |   |   |   | 8.4                                  |   | 12.2 |   | 12.5 |   |
| Amortization of  long-lived assets            |   |   |   | 1.8                                  |   | 2.5 |   | 0.3 |   |
| Impairment of  long-lived assets              |   |   |   | —                               |   | 11.5 |   | — |   |
| Operating income  (loss)                      |   |   |   | 5.2                                  |   | (20.6 | ) | (9.0 | ) |
| Interest income                               |   |   |   | 1.6                                  |   | 1.0 |   | 0.2 |   |
| Interest expense                              |   |   |   | —                               |   | (0.2 | ) | — |   |
| Income (loss)  before income taxes            |   |   |   | 6.8                                  |   | (19.8 | ) | (8.8 | ) |
| Provision for  income taxes (credit)          |   |   |   | 2.2                                  |   | (7.7 | ) | (3.0 | ) |
| Net income  (loss)                            |   |   |   | 4.6                                  |   | (12.1 | ) | (5.8 | ) |

 

## **Fiscal Year EndedNovember 30, 2002 Compared to Fiscal Year Ended November 30, 2001**

 

*Net Sales*.  Net sales in the fiscal year ended November30, 2002 were $55.0 million, an increase of $5.8 million, or 11.7 %, from $49.2million in the fiscal year ended November 30, 2001.  This cumulative increase in net sales represents a $3.7 millionincrease in sales of Security Printing Solutions and an increase of  $2.1 million in sales of Wireless and ConnectivitySolutions.  The increase in sales ofSecurity Printing Solutions resulted from increased orders from existingcustomers for printers and toner supplies. The increase in Wireless andConnectivity Solutions is due to $3.8 million in sales of wired connectivityproducts related to our acquisition of the printing solutions operations ofExtended Systems which was partially offset by reduced sales of other wiredconnectivity products.  Sales ofwireless products were approximately $.9 million and have not met ourexpectations.  We anticipate that salesof wired connectivity products, which constituted a significant portion of ouroverall sales of Wireless and Connectivity Solutions, will decline as theseproducts are at or approaching end of life. Net sales of software licensing revenue included in the Wireless andConnectivity Solutions segment increased from $476,000 in fiscal year endedNovember 30, 2001 to $818,000 in fiscal year ended November 30, 2002.  Net sales were not significantly affected byprice changes.

* *

*Cost of Goods Sold*.  Cost of goods sold increased by $7.2 millionor 23.5 % to $38.0 million in the fiscal year ended November 30, 2002 from$30.8 million in the fiscal year ended November 30, 2001.  This increase was due to increased sales ofSecurity and Printing Solutions products, and the following increased costsrelated to Wireless and Connectivity Solutions:  $2.9 million additional costs as a result of our acquisition ofthe printing solutions operations of Extended Systems, an increase in theinventory reserve of $1.4 million for excess and obsolete inventories, and anadditional amortization charge of $707,000 to write down capitalized softwaredevelopment costs to net realizable value. The net realizable value write down and a significant portion of theincreased inventory reserve is a result of lower forecasted sales for wirelessproducts.  Cost of goods sold as apercentage of net sales increased to 69.1 % in the fiscal year ended November30, 2002 from 62.5% in the fiscal year ended November 30, 2001.  Cost of goods sold could vary due to changesin the mix of wireless and connectivity products and software solutions sold.

* *

*Gross Profit*.  As a result of the above factors, grossprofit decreased by $1.5 million to $17.0 million in the fiscal year endedNovember 30, 2002 from $18.5 million in the fiscal year ended November 30,2001.  Gross profit as a percentage ofnet sales decreased to 30.9 % in the fiscal year ended November 30, 2002 from37.5% in the fiscal year ended November 30, 2001.  Security Printing Solutions and 

 

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Wireless and Connectivity Solutions gross profit as a percentage of netsales decreased by 2.1 % and 6.2%, respectively, in the fiscal year endedNovember 30, 2002 from the fiscal year ended November 30, 2001.

* *

*Selling, General and AdministrativeExpenses*.  Selling,general and administrative expenses decreased by $773,000 or 4.9 % to $14.9million in the fiscal year ended November 30, 2002 from $15.7 million in thefiscal year ended November 30, 2001. This decrease primarily was due to reductions in staff in both SecurityPrinting Solutions and Wireless and Connectivity Solutions.  Selling, general and administrative expensesas a percentage of net sales decreased to 27.1 % in the fiscal year endedNovember 30, 2002 from 31.9% in the fiscal year ended November 30, 2001, due toreductions in expenses.  We intend tocontinue reducing general and administrative expenses while investingselectively in the sales force, and adding technical resources as required.

* *

*Research and Development Expenses*.  Research and development expenses increasedby $845,000 or 14.0 % to $6.9 million in the fiscal year ended November 30,2002 from $6.0 million in the fiscal year ended November 30, 2001 due toinvestments in toner development and financial software, both with respect toSecurity Printing Solutions.  Researchand development expenses as a percentage of net sales was 12.5 % in the fiscalyear ended November 30, 2002 and 12.2% in the fiscal year ended November 30,2001.  We expect research and developmentactivities to focus primarily on our security printing solutions products andto a lesser extent on enhancements to our wireless networking products.However, we have the ability to redirect our research and developmentactivities as needed based on our product strategies and marketopportunities.  We forecast and budgetresearch and development expenses by segment, but not by project.  The anticipated timing for the commercializationof any of our development efforts is not currently known.

* *

*Amortization of IntangibleAssets. *Amortizationof intangible assets decreased by $1.1 million or 89.4 % to $131,000 in thefiscal year ended November 30, 2002 from $1.2 million in the fiscal year endedNovember 30, 2001.  This decrease wasthe result of the write-off in fiscal year 2001 of the impaired intangibleassets associated with our acquisitions.

* *

*Operating Loss*.  As a result of the above factors, werecorded an operating loss of $4.9 million in the fiscal year ended November30, 2002 compared to an operating loss of $10.1 million in the fiscal yearended November 30, 2001.  The operatingloss in both fiscal years primarily was due to losses reported by our Wirelessand Connectivity business (See Note 13 to our financial statements on pageF-21.) The operating loss as a percentage of net sales was 9.0 % in the fiscalyear ended November 30, 2002 compared to an operating loss as a percentage ofnet sales of 20.6% in the fiscal year ended November 30, 2001.

* *

*Interest Income.*  Interest income decreased by $414,000 or80.4 % to $101,000 in the fiscal year ended November 30, 2002 from $515,000 inthe fiscal year ended November 30, 2001. This income was due to our investment of current cash and available forsale securities and our cash flows provided by operations.  This decrease is the result of lower rates onour investments in available for sale securities due to our acquisitions, ourstock repurchase program and working capital requirements.

* *

*Interest Expense*.  Interest expense decreased by $104,000 to$34,000 in the fiscal year ended November 30, 2002 from $138,000 in the fiscalyear ended November 30, 2001.  Thisdecrease was due to reduced borrowings under our line of credit.

* *

*Income Taxes*.  We reported an income tax credit of $1.7million in the fiscal year ended November 30, 2002 compared to income taxcredit of $3.8 million in the fiscal year ended November 30, 2001.  The credit was due to our operating loss andincreases in research and development and other tax 

 

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credits.  The recoverability ofour deferred tax asset is dependant on our ability to generate future taxableincome.

 

## **Fiscal Year EndedNovember 30, 2001 Compared to Fiscal Year Ended November 30, 2000**

* *

*Net Sales*.  Net sales in the fiscal year ended November30, 2001 were $49.2 million, a decrease of $3.1 million, or 5.9%, from $52.3million in the fiscal year ended November 30, 2000.  This cumulative decrease in net sales represents a $5.1 milliondecrease in sales of Security Printing Solutions due to an economic slowdown,which was partially offset by an increase of $2.0 million in sales of Wirelessand Connectivity Solutions.  Net salesduring the fiscal year ended November 30, 2001 in the Wireless and ConnectivitySolutions segment include $4.8 million related to our acquisition of theprinting solutions operations of Extended Systems.  Net sales of software licensing revenue included in the Wirelessand Connectivity Solutions segment decreased from $2.8 million in fiscal yearended November 30, 2000 to $476,000 in fiscal year ended November 30,2001.  Net sales were not significantlyaffected by price changes.

* *

*Cost of Goods Sold*.  Cost of goods sold increased by $713,000 or2.4% to $30.8 million in the fiscal year ended November 30, 2001 from $30.1million in the fiscal year ended November 30, 2000.  This increase primarily was due to $2.5 million additional costsas a result of our acquisition of the printing solutions operations of ExtendedSystems and an increase in the inventory reserve of $1.6 million for excess andobsolete inventories, both in Wireless and Connectivity Solutions, partiallyoffset by reductions due to lower sales in Security Printing Solutions.  The increase in the reserve for excess andobsolete inventories partially resulted from an analysis of our long-livedassets and could vary significantly in future years.  Cost of goods sold as a percentage of net sales increased to62.5% in the fiscal year ended November 30, 2001 from 57.5% in the fiscal yearended November 30, 2000.

* *

*Gross Profit*.  As a result of the above factors, grossprofit decreased by $3.8 million to $18.5 million in the fiscal year endedNovember 30, 2001 from $22.3 million in the fiscal year ended November 30,2000.  Gross profit as a percentage ofnet sales decreased to 37.5% in the fiscal year ended November 30, 2001 from42.5% in the fiscal year ended November 30, 2000.

* *

*Selling, General and AdministrativeExpenses*.  Selling,general and administrative expenses increased by $1.5 million or 10.5% to $15.7million in the fiscal year ended November 30, 2001 from $14.2 million in thefiscal year ended November 30, 2000. This increase primarily was due to additional operating expenses of$942,000 as a result of our acquisition of the printing solutions operations ofExtended Systems Incorporated.  Selling,general and administrative expenses as a percentage of net sales increased to31.9% in the fiscal year ended November 30, 2001 from 27.1% in the fiscal yearended November 30, 2000, due to our acquisition strategy and our associatedgrowth requirements.

* *

*Research and Development Expenses*.  Research and development expenses increasedby $1.7 million or 37.9% to $6.0 million in the fiscal year ended November 30,2001 from $4.4 million in the fiscal year ended November 30, 2000.  Research and development expenses as apercentage of net sales was 12.2% in the fiscal year ended November 30, 2001and 8.4% in the fiscal year ended November 30, 2000.

 

We capitalizecertain software development costs in accordance with Financial AccountingStandards Board (FASB) Statement No. 86, Accounting for the Costs of ComputerSoftware to be Sold, Leased, or Otherwise Marketed.  Under the provisions of FASB No. 86, we capitalize computer softwaredevelopment costs from the point that technological feasibility is establisheduntil the time when the product is available for general release to thepublic.  Research and development costs,consisting of software development costs incurred until the point oftechnological feasibility, are charged to operations 

 

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when incurred.  Softwaredevelopment costs capitalized were $154,000 during fiscal year ended November30, 2000 compared to $1.3 million during fiscal year ended November 30, 2001.  We anticipate the estimated lives of theseproducts to be approximately five years.

* *

*Amortization of IntangibleAssets. *Amortizationof intangible assets increased by $252,000 or 25.6% to $1.2 million in thefiscal year ended November 30, 2001 from $1.0 million in the fiscal year endedNovember 30, 2000.  This increase wasthe result of increases in the intangible assets associated with ouracquisitions.

* *

*Impairment of Long-Lived Assets*.  During the fourth quarter of fiscal year2001, we initiated an analysis of long-lived assets in accordance with Statement of Financial AccountingStandards No. 121, “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to be Disposed Of” (“SFAS 121”), to determine if there wasimpairment of  long-lived assets.  This analysis was initiated due to changesin our business environment, which were highlighted during our annual businessplanning process, and certain changes in our management. This analysis was doneon a business unit by unit basis as it was determined that these units wereindependent of each other and were the lowest level for which cash flows couldbe identified.  The business unitsidentified were similar to the businesses acquired by us since 1998.  The analysis demonstrated that the acquiredprint server products and technologies were at or approaching their end-of lifeand that the ACH processing services were not generating the cash flowsanticipated when this business unit was acquired.  We completed this analysis with the assistance of an independentvaluation firm.  The analysis indicatedthat these business units would not generate sufficient positive cash flowsover the projected period of five years, which approximated the remaining lifeof the long-lived assets, and that there was no current value or residual valuebeyond the value of the net current assets and certain property andequipment.  Substantially all of theintangible assets of certain of these business units were written off atNovember 30, 2001 because they were projected to generate insufficient positivecash flows.  Certain property andequipment of these business units were not written off because they continue tobe used in operations and were determined to have value.  As a result of this analysis, we recorded acharge in 2001 of $5,634,000 for the impairment of long-lived assets on abusiness unit by unit basis as follows:

 
| **Business Unit**     |   | **Amount** |      | **Segment**                  |                       |
|-----------------------|--------|------------|-----------|------------------------------|----------------------------|
|                  |   |       |      |                         |                       |
| XCD                   |   | $          | 1,085,000 |                         | Wireless and  Connectivity |   |
| American  Development |   | 1,945,000  |      | Security Printing  Solutions |                       |
| CableNet              |   | 2,074,000  |      | Wireless and  Connectivity   |                       |
| ESI                   |   | 530,000    |      | Wireless and  Connectivity   |                       |
| Total                 |   | $          | 5,634,000 |                         |                       |   |

 

The amortizationexpense recorded for these assets in 2001 prior to the recorded impairmentcharge was $1,261,000.

 

At November 30,2001, we had $2,470,000 in intangible assets that was determined to be notimpaired. Included in this amount are capitalized software development costsrelated to new Wireless and Connectivity products and StarACHTM, our newest ACHsoftware product.  Amortization expenseon these intangible assets in 2002 was $520,000.

* *

*Operating Income (Loss)*.  As a result of the above factors, werecorded an operating loss of $10.1 million in the fiscal year ended November30, 2001 compared to operating income of $2.7 million in the fiscal year endedNovember 30, 2000.  The operating lossas a percentage of net sales was 20.6% in the fiscal year ended November 30,2001 compared to operating income as a percentage of net sales of 5.2% in thefiscal year ended November 30, 2000.

 

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*Interest Income.*  Interest income decreased by $350,000 or40.5% to $515,000 in the fiscal year ended November 30, 2001 from $865,000 inthe fiscal year ended November 30, 2000. This income was due to our investment of current cash and available forsale securities and our cash flows provided by operations.  This decrease is the result of lower rateson our investments in available for sale securities due to our acquisitions,our stock repurchase program and working capital requirements.

* *

*Interest Expense*.  Interest expense increased by $119,000 to$138,000 in the fiscal year ended November 30, 2001 from $19,000 in the fiscalyear ended November 30, 2000.  Thisincrease was due to increased borrowings under our line of credit.

* *

*Income Taxes*.  We reported an income tax credit of $3.8million in the fiscal year ended November 30, 2001 compared to income taxexpense of $1.2 million in the fiscal year ended November 30, 2000.  The credit was due to our operating loss andincreases in research and development and other tax credits.  The recoverability of our deferred tax assetis dependent on our ability to generate future taxable income.

 

## **Backlog**

 

We sell our products on a purchase order basis rather than throughlong-term contracts.  Because wetypically ship product within 30 days of order and customers may cancel orreschedule deliveries, we do not consider backlog to be a reliable indicator offuture financial results.

 

## **Liquidity andCapital Resources**

 

Cash flowsprovided by operating activities were $1.4 million in the fiscal year endedNovember 30, 2002 compared to $763,000 provided by operating activities in thefiscal year ended November 30, 2001. This increase was due primarily to reductions in inventories andaccounts receivable and a reduced net loss.

 

Cash flowsprovided by investing activities were $4.0 million in the fiscal year endedNovember 30, 2002 compared to cash flows provided by investing activities of$217,000 in the fiscal year ended November 30, 2001.  Included in cash flows provided by investing activities in thefiscal year ended November 30, 2002 was $4.7 million in net maturities ofavailable-for-sale securities.

 

Cash flows used infinancing activities were $1,000 in the fiscal year ended November 30, 2002compared to cash flows used in financing activities of $1.0 million in thefiscal year ended November 30, 2001. The decrease in cash used in financing activities primarily resultedfrom $1.1 million of purchases in the stock repurchase program in the fiscalyear ended November 30, 2001.

 

We have a$5,000,000 line-of-credit agreement with Comerica Bank.  As of November 30, 2002, there were noborrowings outstanding against the line of credit.  Borrowings under the line of credit bear interest at the lesserof the bank’s reference rate (4.25 % at November 29, 2002) less 0.25% or thebank’s LIBOR rate (1.44 % at November 29, 2002) plus 2% and are limited to 80%of eligible accounts receivable and 50% of eligible inventories if totalliabilities to tangible effective net worth is greater than two to one.  In connection with the line-of-creditagreement, we have a $650,000 standby letter-of-credit sublimit agreement ofwhich approximately $80,000 was outstanding at November 30, 2002.  This line of credit is secured bysubstantially all of our assets.  Ourborrowing arrangement requires us to comply with certain financial covenants.As of November 30, 2002, we had approximately $4,920,000 in availability underthe line of credit.  The line-of-creditborrowings are due on demand.  Theagreement may be terminated by either party.

 

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We believe thatexisting cash balances, cash generated by operating activities, and funds availableunder our credit facility will be sufficient to finance our operatingactivities for at least the next 12 months, which will include expenditures ofapproximately $1.9 million for toner compounding equipment, and approximately$400,000 for a new ERP system.  To theextent that the funds generated from these sources are insufficient to financeour operating activities, we would need to raise additional funds throughpublic or private financing.  We cannotassure you that additional financing will be available on terms favorable tous, or at all.

 

In March 2001,Troy established a stock repurchase program under which TROY’s common stock,with an aggregate market value up to $4.0 million, may be acquired in the openmarket.  As of November 30, 2002, Troy haspurchased approximately 320,565 shares of common stock in the open market, atan average price of $3.67 per share, under the stock repurchase program.  Approximately $2.8 million remain availablefor future common stock repurchases.

 

**Critical Accounting Policies**

* *

# ***Application of Critical AccountingPolicies***

Our significantaccounting policies are described in Note 1 to the consolidated financialstatements included in Item 8 of this Form 10-K.  Critical accounting policies are defined as those that are themost important to the accurate portrayal of our financial condition and resultsof operations. Critical accounting policies require management’s subjectivejudgment and may produce materially different results under differentassumptions and conditions. Our operations are affected by numerous factorsincluding market acceptance, changes in technologies and new laws andgovernment regulations and policies.  Wecannot predict what impact, if any, the occurrence of these or other eventsmight have on our operations. Significant estimates and assumptions made by management are used for,but not limited to, the allowance for doubtful accounts, the reserve for slowmoving or obsolete inventories, the fair value of long-lived and intangibleassets and the realizability of deferred tax assets. We have discussed thedevelopment and selection of these critical accounting policies with the AuditCommittee of our Board of Directors, and the Audit Committee has reviewed andapproved our related disclosure in this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations. The following are our criticalaccounting policies:

*Inventories*

We value inventories at the lower of cost or market ona first-in, first-out basis.  We use astandard cost system for purposes of determining cost.  The standards are adjusted periodically toensure they approximate actual costs. We include materials, labor and manufacturing overhead in the cost ofinventories.  We write down the carryingvalue of our inventory to market value for based upon assumptions about futuredemand and market conditions.  Wecompare current inventory levels on a product basis to our current salesforecasts in order to assess our inventory balance.  Our sales forecasts are based on economic conditions and trends(both current and projected), anticipated customer demand, expected futureproducts and other assumptions.  Ourestimates may differ from actual results due to the quality, quantity and mix ofproducts in inventory, customer preferences and economic conditions and as aresult, additional write-downs may be required.

*Capitalizationof software development costs*

Costs incurred in the research, design and development of software forsale to others as a separate product or embedded in a product and sold as partof the product as a whole are charged to expense until technologicalfeasibility is established.  Thereafter,software development costs are capitalized and amortized to product cost ofsales on a straight-line basis over the lesser of five years or the estimatedeconomic lives of the respective products, beginning when the products areoffered for sale. Ateach balance sheet date, we compare the unamortized capitalized costs to thenet realizable value of that product. The net realizable value is the estimatedfuture gross revenues from that product reduced by the estimated future costsof completing and disposing of that product, including the costs of performingmaintenance and customer support required to satisfy our responsibility setforth at the time of sale. For developed software components of a product orprocess marketed as an integral part of that product or process and not soldseparately, we evaluate net realizable value of that component with the totalsystem.  We determine net realizablevalue considering many of the same factors we use in establishing reserves forestimated obsolete or excess inventory.

 

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*Long-livedand intangible assets*

Depreciation and amortization of our long-lived assets is providedusing the straight-line method over their estimated useful lives. Changes incircumstances such as the passage of new laws or changes in regulations,technological advances, changes to the Company’s business model or changes inthe capital strategy could result in the actual useful lives differing frominitial estimates. In those cases where we determine that the useful life of along-lived asset should be revised, we will depreciate the net book value inexcess of the estimated residual value over its revised remaining useful life.Factors such as changes in the planned use of equipment, customer attrition,contractual amendments or mandated regulatory requirements could result inshortened useful lives.

 

We periodically review the value of our long-lived andintangible assets to determine if impairment has occurred by comparing thecarrying value of the long-lived assets with the lowest level of identifiablefuture net undiscounted cash flows expected to result from the use of theassets, including cash flows from disposition. As discussed in Note 14 to the consolidated financial statements, werecorded an impairment loss on certain long-lived assets during fiscal year2001 based on an evaluation of projected operating income, cash flows andbusiness prospects. In addition, we determined other long-lived assets were notimpaired. In making these determinations, the assumptions used by managementabout future cash flows are critical. If these expected cash flows are not realized, future additionalimpairment losses may be recorded.

*Revenuerecognition*

We recognize revenue from the sale of our equipmentand supplies to end users, distributors, original equipment manufacturers (OEM)and resellers when the product is shipped and the title is transferred to thebuyer, net of an allowance for estimated returns, as long as no significantpost-delivery obligations exist and collection of the resulting receivable isprobable. Revenue from equipment maintenance contracts is recorded as deferredincome when billed and is recognized straight-line over the term of thecontract.  We provide for estimatedreserves based upon our historical rates of returns and allowances.  Actual returns in any future period areinherently uncertain and thus may differ from our estimates.  We accrue for warranty expense at the timerevenue is recognized and maintain a warranty accrual for estimated futurewarranty obligations based upon the relationship between historical andanticipated warranty costs and sales volumes. To the extent we experience increased warranty claim activity orincreased costs associated with servicing those claims, our warranty accrualwill increase resulting in decreased gross profit.

We recognize revenue from software arrangements inaccordance with Statement of Position (“SOP”) 97-2, “Software RevenueRecognition” as amended by SOP 98-9, “Modification of SOP 97-2 with Respect toCertain Transactions.” Revenue is recognized when persuasive evidence of anarrangement exits and delivery has occurred, provided the fee is fixed ordeterminable, collectibility is probable and the arrangement does not requiresignificant customization or modification of the software.  For arrangements where the software requiressignificant customization or modification, the Company recognizes revenue forthe software license and consulting services portion of the arrangement uponcustomer acceptance.  Maintenancerevenue is recognized ratably over the term of the maintenance contract,typically 12 months.

Revenue fromsoftware license agreements with OEMs whereby the Company provides ongoingsupport over the term of the contract is recognized based on the greater ofroyalties’ earned or straight line over the term of the contract.

 

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*Allowance for doubtful accounts*

We maintain an allowance for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments.  The amount of the reserve isbased on historical experience and our analysis of the accounts receivableoutstanding.  If the financial conditionof our customers were to deteriorate, resulting in an impairment of theirability to make payments, additional allowances may be required which wouldresult in an additional expense in the period such determination was made.

*Incometaxes*

Deferred taxes are provided on aliability method whereby deferred tax assets are recognized for deductibletemporary differences and operating loss and tax credit carryforwards anddeferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differencesbetween the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by avaluation allowance when it is determined to be more likely than not that someportion or all of the deferred tax assets will not be realized. In evaluatingthe need for a valuation allowance, we consider future taxable income,resolution of tax uncertainties and prudent and feasible tax planningstrategies. If we determine that we would not be able to realize all or part ofour deferred tax assets in the future, an adjustment to the carrying value ofthe deferred tax assets would be charged to income in the period in which such determinationwas made and may affect our annual effective income tax rate.

 

*Stock-basedcompensation*

As allowed by SFAS No. 123, we haveelected to continue to account for our employee stock-based compensation planusing the intrinsic value method in accordance with Accounting Principles Board(APB) Opinion No. 25, Accounting for Stock Issued to Employees, and relatedInterpretations, which does not require compensation to be recorded if theconsideration to be received is at least equal to the fair value of the commonstock to be received at the measurement date. Nonemployee stock-basedtransactions are accounted for under the requirements of StatementNo. 123, *Accounting for Stock-Based Compensation*, which requirescompensation to be recorded based on the fair value of the securities issued orthe services received, whichever is more reliably measurable.

* *

 

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## ** **

## **ContractualObligations and Commercial Commitments**

 

We have thefollowing contractual obligations and commercial commitments. 

 
|                                |   | **Total** |      | **1-3 years** |   | **4-5 years** |    | **After 5  years** |    |
|-------------------------------------|--------|-----------|-----------|---------------|--------|---------------|---------|--------------------|---------|
| Notes Payable                       |   | $         | 193,000   |          | $      | 193,000       |    | —             |    | — |   |
| Related party  operating lease      |   | 1,438,000 |      | 809,000       |   | $             | 539,000 |               | $       | 90,000 |   |
| Other operating  leases             |   | 631,000   |      | 631,000       |   | —        |    | —             |    |
| Split dollar  life insurance policy |   |      | **        |          | **     |          | **      |               | **      |
| Total                               |   | $         | 2,262,000 |          | $      | 1,633,000     |    | $                  | 539,000 |   | $ | 90,000 |   |

 

The annual commitments reflected in the table above are based on ourNovember 30 year-end.

 

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**We previouslyhad committed to making payments on the split dollar life insurance policybased on continued employment. As of November 30, 2001 and November 30, 2002,wehad advanced $1,666,000 and $2,123,000, respectively, to stockholders inconnection with the purchase of split dollar life insurance policies.  Troy and the stockholders have executedsplit-dollar agreements governing the unsecured non-interest bearing advances.The advances are due on demand, however we do not anticipate demanding paymentin the next 12 months and accordingly we have classified this amount aslong-term.  The Sarbanes-Oxley Act of2002 prohibits extensions of credit in the form of a personal loan to certaincompany insiders after July 29, 2002. As a result, since July 29, 2002 the Company has not funded the annualpremium payments on these policies.  Ifthe SEC issues new regulations or other guidance that causes us to reevaluateour position, we may demand payment on the advance and terminate ourparticipation in these arrangements. Annual premiums on these policies are approximately $585,000 per yearfor the next five years.

 

## **Recently Issued Accounting Standards**

 

In June 2001, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 141 (SFAS No. 141), *Business Combinations*, andStatement of Financial Accounting Standards No. 142 (SFAS No. 142), *Goodwill andOther Intangible Assets*. SFAS No. 141 addresses financial accounting and reporting for businesscombinations and is effective for all business combinations after June 30,2001.  SFAS No. 142 addresses financialaccounting and reporting for acquired goodwill and other intangible assets andis effective for fiscal years beginning after December 15, 2001.  We will adopt SFAS No. 142 as of thebeginning of fiscal year 2003.  We arein the process of determining the expected impact on earnings and existinggoodwill and other intangibles upon adoption, which will include theelimination of goodwill amortization and may include additional impairment.  As of November 30, 2002, unamortizedgoodwill totaled $235,000.

 

The FASB recentlyissued SFAS No. 143, *Accounting for Asset Retirement Obligations*,addressing financial accounting and reporting for obligations associated withthe retirement of tangible long-lived assets and the associated assetretirement costs.  SFAS No. 143 requiresan enterprise to record 

 

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the fair value of an asset retirement obligation as a liability in theperiod in which it incurs a legal obligation associated with the retirement ofa tangible long-lived asset.  SFAS No.143 also requires the enterprise to record the contra to the initial obligationas an increase to the carrying amount of the related long-lived asset and todepreciate that cost over the remaining useful life of the asset.  The liability is changed at the end of eachperiod to reflect the passage of time and changes in the estimated future cashflows underlying the initial fair value measurement. SFAS No. 143 is effectivefor fiscal years beginning after June 15, 2002.  We are currently examining the impact of this pronouncement onthe results of our operations and financial position.

 

In August 2001,the FASB issued SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, which supersedes previous guidance on financialaccounting and reporting for the impairment or disposal of long-lived assetsand for segments of a business to be disposed of.  Adoption of SFAS 144 is required no later than the beginning offiscal 2003.  Management does not expectthe adoption of SFAS 144 to have a significant impact on our financial positionor results of operations.  However,further impairment reviews may result in charges against earnings to write downthe value of long-lived assets.

 

In June 2002, theFASB issued SFAS No. 146 *Accounting forCosts Associated with Exit or Disposal Activities.*  SFAS No. 146 generally requires companies torecognize costs associated with exit or disposal activities when they areincurred rather than at the date of a commitment to an exit or disposalplan.  This pronouncement is effectivefor exit or disposal activities initiated after December 31, 2002.  Statement 146 is not expected to have amaterial impact on the Company’s results of operations or financial position.

 

In December 2002,the FASB issued Interpretation No. 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*. Interpretation No. 45 requiresthat at the time a company issues a guarantee, the company must recognize aninitial liability for the fair value, or market value, of the obligations itassumes under that guarantee.  Thisinterpretation is applicable on a prospective basis to guarantees issued ormodified after December 31, 2002.  TheInterpretation is not expected to have a material impact on the company’sresults of operations or financial position.

 

In January 2003, the Financial Accounting StandardsBoard issued FASB Interpretation No. 46 (FIN 46), *Consolidation of Variable Interest Entities, anInterpretation of Accounting Research Bulletin No. 51*” Prior toFIN 46, a company generally included another entity in the company’s financialstatements only if it controlled the entity through ownership of the majorityvoting interests.  FIN 46 requirescertain variable interest entities to be consolidated by the primarybeneficiary of the entity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties. FIN 46 is effective for allnew variable interest entities created or acquired after January 31, 2003.For variable interest entities created or acquired prior to February 1,2003, the provisions of FIN 46 must be applied for the quarter ending August31, 2003. We are currently analyzing the effect that the adoption of FIN 46will have on our results of operations and financial position, but expect thatupon the implementation date, it is reasonably possible that we will berequired to consolidate the related party leasing entity described Note 10 tothe consolidated financial statements.

The financial statements ofthe related party leasing entity for the year ended November 30, 2002 are currently not available;however, management estimates that if this entity is required to beconsolidated under the provisions of FIN 46, it would have no impact onrevenues and an insignificant impact on net income.  The assets, primarily land and building, would be less than 5% oftotal assets, the related liabilities, primarily notes payable to the bank,would be approximately 10% of total liabilities and the net effect onstockholders' equity would not be material.

 

The Company paid a total of $270,000 to lease themanufacturing facility during each of the years ended November 30, 2002, 2001,and 2000 respectively.  The futureminimum lease commitments are included in Note 10.

 

When FIN 46 becomeseffective, the net amount that may be added to the Company’s balance sheet mayeither be reported as the cumulative effect of an accounting change, or byrestating previously issued financial statements with a cumulative-effectadjustment as of the beginning of the first year restated.  The company has not yet determined themanner in which it will adopt FIN 46 in the event it is required to consolidatethe entity.

 

In December 2002,the Financial Accounting Standards Board issued FASB Statement No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure*.  Thisstatement amends FASB Statement No. 123, *Accountingfor Stock-Based Compensation*, to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. This statement does not require any change from the method currentlyused by the Company to account for stock-based compensation, but does requiremore prominent disclosure in the annual financial statement about the method ofaccounting for such compensation and the effect of the method used on reportedresults. This statement is effective for years ending after December 15,2002.  The Company has not yet adoptedthe disclosure provisions of SFAS No. 148 in the accompanying financialstatements.

 

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# **Item 7a.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK.**

 

Market risk is therisk of loss to future earnings, to fair values or to future cash flows thatmay result from changes in the price of a financial instrument.  The value of a financial instrument maychange as a result of changes in interest rates, exchange rates, commodityprices, equity prices and other market changes.  Market risk is attributed to all market sensitive financialinstruments, including long-term debt.

 

We do not utilizederivative financial instruments. Accordingly, our exposure to market risk is through our investments inavailable-for-sale securities and our bank debt which bears interest atvariable rates.  Available-for-salesecurities consist of certificates of deposit. These securities generally have contractual maturity dates of up to oneyear.  At November 30, 2002, marketvalues approximated carrying values. Due to the short-term maturities of these securities, managementbelieves that there is no significant market risk.  At November 30, 2002, we had approximately $7.1 million in cash,cash equivalents and investments in available-for-sale securities, and, accordingly,a sustained decrease in the rate of interest earned of 1% would cause adecrease in the amount of interest earned of $71,000.  The bank debt is a revolving line of credit.  Borrowings under the line of credit bearinterest at the lesser of the bank’s reference rate (4.25 % at November 29,2002) less 0.25% or the bank’s LIBOR rate (1.44 % at November 29, 2002) plus 2%and are limited to 80% of eligible accounts receivable and 50% of eligibleinventories if total liabilities to tangible effective net worth is greaterthan two to one.  At November 30, 2002,there were no amounts outstanding under the line of credit agreement and,accordingly, a sustained increase in the reference rate of 1% would not causeour annual interest expense to change.

 

30

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# **Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.**

* *

*Financial Statements*.

 

Our consolidatedfinancial statements and related notes are contained on pages F-1 to F-25 ofthis report.  The index to such items isincluded on page 44 in Item 15(a)(1).

 

 

The quarterlyresults for the first and second quarter of fiscal 2002 have been restated toreflect the recording of certain inventory and inventory related accountspayable adjustments discovered in the third quarter of fiscal 2002 to therelevant periods. During the third quarter physical inventory counts wereconducted and certain inventory adjustments were discovered. The Companycompleted a comprehensive review of its inventory related internal controls todetermine the cause of the identified inventory differences. The Company hasdetermined that certain differences arising from inventory and inventoryrelated accounts payable were attributable to the first and second quarters offiscal 2002. The Company has restated the results of those quarters andassociated year-to-date amounts in those periods and filed amended Forms 10-Q.

* *

*Quarterly Results*

 

Fiscal 2002 (unaudited)

(in thousands, except pershare data)

 
|                 |   | **First  Quarter** |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
|----------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|
|                 |   | **(Restated)**     |   | **(Restated)**      |   |               |   |                |   |
| Net  sales           |   | $                  | 13,571 |                | $      | 14,025             |   | $                   | 13,649 |   | $ | 13,753 |   |
| Gross profit         |   | 5,414              |   | 5,538               |   | 3,335              |   | 2,700               |   |
| Operating loss       |   | (298               | )      | (202                | )      | (1,806             | )      | (2,618              | )      |
| Net loss             |   | (180               | )      | (112                | )      | (1,165             | )      | (1,718              | )      |
| Net loss per  share: |   |               |   |                |   |               |   |                |   |
| Basic                |   | (.02               | )      | (.01                | )      | (.11               | )      | (.16                | )      |
| Diluted              |   | (.02               | )      | (.01                | )      | (.11               | )      | (.16                | )      |
|                      |        |                    |        |                     |        |                    |        |                     |        |  |  |  |  |

 

In the fourth quarter of fiscal year 2002, the Companyperformed an extensive analysis of the Wireless and Connectivity segment due tochanges in the economic, technical and competitive conditions that occurredduring this period.  As a result of thisanalysis, the Company recorded a charge for excess and obsolete inventories of$1,878,000, and recorded an amortization charge of $707,000 to write downcapitalized software development costs to net realizable value during thefourth quarter.

 

Fiscal 2001 (unaudited)

(in thousands, except pershare data)

 
|                          |   | **First  Quarter** |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
|-------------------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|
| Net  sales                    |   | $                  | 11,309 |                | $      | 9,800              |   | $                   | 13,674 |   | $ | 14,435 |   |
| Gross profit                  |   | 4,453              |   | 3,574               |   | 5,513              |   | 4,912               |   |
| Operating income  (loss)      |   | (1,181             | )      | (2,402              | )      | 230                |   | (6,772              | )      |
| Net income  (loss)            |   | (585               | )      | (1,581              | )      | 220                |   | (3,999              | )      |
| Net income  (loss) per share: |   |               |   |                |   |               |   |                |   |
| Basic                         |   | (.05               | )      | (.15                | )      | .02                |   | (.37                | )      |
| Diluted                       |   | (.05               | )      | (.15                | )      | .02                |   | (.37                | )      |
|                               |        |                    |        |                     |        |                    |        |                     |        |  |  |  |  |

 

During the fourthquarter of fiscal 2001, we recorded a charge for the impairment of long-livedassets of $5.6 million and increased the reserve for obsolete and excessinventory by $1.1 million.  See Note 14in the “Note to Consolidated Financial Statements” for additional discussion.

 

An expense on thequarterly statements of income for fiscal years 2001 and 2002 has beenreclassified with no effect on net income or earnings per share to beconsistent with the classification adopted for the year ended November 30,2002.

 

Quarterlycalculations of net earnings per share do not equate to the calculations forthe fiscal year as quarterly calculations are made on a discrete basis.

 

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# **Item 9.**           CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

*Changes in Accountants*

 

On May 31, 2002,our Audit Committee approved a change in auditors and our Board of Directorsratified the Audit Committee’s dismissal of McGladrey & Pullen LLP.    We completed a formal engagement letterwith KPMG LLP to serve as our independent public accountants on July 5, 2002.

 

On January 13,2003, our Audit Committee again approved a change in auditors and our Board ofDirectors ratified the Audit Committee’s dismissal of KPMG LLP as ourindependent public accountants.   Wecompleted a formal engagement letter with McGladrey & Pullen LLP to serveas our independent public accountants on February 3, 2003.

 

The informationrequired by Item 304(a) of Regulation S-K regarding these changes in ouraccountants has been previously reported on Forms 8-K filed on June 4, 2002,July 9, 2002, January 21, 2003 and February 7, 2003.

* *

*Disagreements or Reportable Events.*

 

During our fiscalyears ended November 30, 2001 and 2000 and the subsequent interim periodthrough May 28, 2002, the date we dismissed McGladrey and Pullen, there were nodisagreements between us and McGladrey & Pullen on any matter of accountingprinciples or practices, financial statement disclosure, or auditing scope orprocedure, and there were no reportable events as described in Item304(a)(1)(v) of Regulation S-K.

 

During the periodfrom July 5, 2002 through January 13, 2003, the date we dismissed KPMG, exceptas set forth in the paragraphs below, there were no disagreements between TROYand KPMG on any matter of accounting principles or practices, financialstatement disclosure,  and there were noreportable events as described in Item 304(a)(1)(v) of Regulation S-K.

 

On October 15, 2002,we issued a press release announcing that the filing of our Form 10-Q for thefiscal quarter ended August 31, 2002 would be delayed. We had conductedphysical inventory counts and discovered certain inventory adjustments. Wedelayed the filing of our Form 10-Q for the fiscal quarter ended August 31,2002 in order to give us sufficient time to review the causes of such inventoryadjustments and to determine if any of the financial statements for priorperiods would need to be restated.

 

At the time of theirdismissal, KPMG had not completed their review of the procedures andmethodology used by us in our review of the inventory adjustments in order todetermine the final amount of the adjustments and which prior periods wouldneed to be restated. Because these adjustments pertained to periods in whichMcGladrey & Pullen served as our independent auditors, our procedures andmethodology needed to be reviewed by McGladrey. KPMG had previously advised usthat the adjustments could have a material impact on the financial statementsfor the first and second quarters of fiscal 2002 and fiscal 2001.

 

KPMG had alsoexpressed a concern regarding material weaknesses in our inventory accountingcontrols. Since that time, we have implemented a number of corrective measuresthat we believe addresses these concerns.

 

32

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**PART III**

** **

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** **

# **Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT.**

 
| **Name**               |   | **Age** |   | **Position with TROY Group**                                                                                              |   | **Director Since** |
|------------------------|--------|---------|--------|---------------------------------------------------------------------------------------------------------------------------|--------|--------------------|
|                   |   |    |   |                                                                                                                      |   |               |
| Patrick J. Dirk        |   | 63      |   | Chairman of the Board, Director and Chief Executive  Officer of Troy Group and related subsidiaries                       |   | 1982               |
|                   |   |    |   |                                                                                                                      |   |               |
| Brian P. Dirk          |   | 38      |   | Vice Chairman of the Board, Director, Corporate  Secretary and Senior Vice President, Corporate Development of Troy Group |   | 1999               |
|                   |   |    |   |                                                                                                                      |   |               |
| Norman B. Keider(1)    |   | 71      |   | Director                                                                                                                  |   | 1999               |
|                   |   |    |   |                                                                                                                      |   |               |
| John B. Zaepfel(2)     |   | 66      |   | Director                                                                                                                  |   | 1999               |
|                   |   |    |   |                                                                                                                      |   |               |
| Dr. Harold L. Clark(3) |   | 67      |   | Director                                                                                                                  |   | 1999               |
|                   |   |    |   |                                                                                                                      |   |               |
| James W. Klingler      |   | 55      |   | Vice President-Finance, Treasurer and Chief  Financial Officer of Troy Group                                              |   |               |

 

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(1)          Chairman of CompensationCommittee, Member of Audit Committee

(2)          Chairman of AuditCommittee, Member of Compensation Committee

(3)          Member of AuditCommittee and Compensation Committee

 

*Patrick J. Dirk*has been Chairman of the Board, Chief Executive Officer and a Director since heco-founded TROY with his wife in May 1982. From May 1982 until August 1999, Mr. Dirk served as President of TROY..  Mr. Dirk is also Chairman of theBoard and Chief Executive Officer of TROY’s subsidiaries.  From 1973 until 1982, Mr. Dirk was employedin various capacities by Kroy Inc., a manufacturer of automated letteringmachines and related products, serving as President and a director from 1980 to1982.   Mr. Dirk devotes substantiallyall of his efforts to TROY and its subsidiaries.  Mr. Dirk is the father of Brian P. Dirk.

* *

*Brian P. Dirk* wasappointed Vice Chairman of the Board, Corporate Secretary and Senior VicePresident, Corporate Development of TROY on December 1, 2001.  Previously, he served as Vice Presidentsince May 1996.  He was a member of ourBoard of Directors from that date until October 30, 1998.  He again became a director in July 1999.  In addition to managing our financialsoftware and services business, Mr. Dirk’s duties include managing ouracquisition and alliance strategies and staff. Prior to this, he served as Vice President of International and FederalGovernment Sales.  Since joining us in1989, Mr. Dirk has held various management positions, including Vice Presidentof Business Development and Vice President of International Sales.  Mr. Dirk is the son of Patrick J. Dirk.

* *

*Norman B. Keider*has been a Director since July 1999. Since August 1993, Mr. Keider has been a self-employed managementconsultant.  Mr. Keider served as aManaging Director of A.T. Kearney, an 

 

33

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executive search-consulting firm from January 1989 to August 1993.  From April 1986 to January 1989, he was apartner with Keider-Zupsic Associates, an executive search consultingcompany.  Mr. Keider also served as apartner for Arthur Young & Company, an accounting and consulting companyfrom December 1979 to April 1986.  FromJanuary 1978 to December 1979, he was a self-employed consultant foracquisition searches.  From December1972 to January 1978, Mr. Keider was the President and Chief Executive Officerof Atlas Powder Company, a manufacturer of commercial explosives.

* *

*John B. Zaepfel*has been a Director since July 1999. Since June 1991, Mr. Zaepfel has been a Managing Partner of the ZaepfelGroup, a middle market consulting firm specializing in strategic facilitationand planning.  Mr. Zaepfel has served asChief Executive Officer of several companies. He currently serves as a Director for nine companies including onepublicly traded company, RemedyTemp, Inc. From January 1985 to May 1989, Mr. Zaepfel was the founder and ChiefExecutive Officer of CPG International, Inc., a manufacturer and marketer offine art, graphic art, engineering, drafting and media supplies.  From 1974 to 1984, Mr. Zaepfel was Presidentand Chief Executive Officer of Chartpak and Pickett Industries, thenwholly-owned subsidiaries of Times Mirror. Mr. Zaepfel was General Manager of Chartpak, a division of AveryInternational from 1990 to 1993.

* *

*Dr. Harold L. Clark*has been a Director since July 1999. Dr. Clark has been serving as an advisor to technology companies sincehis resignation as Chairman of Max Internet Communications in November 2000.  Prior to this position, Dr. Clark served asXCD’s Chairman from July 1995 until it became Troy Group XCD in October1998.  From April 1993 to August 1995,Dr. Clark was the Chief Executive Officer and Co-Chairman of AmeriQuestTechnologies, Inc., a distributor of computer technology solutions to value-addedresellers, systems integrators, distributors and computer dealers.  Dr. Clark also acted as a consultant toAmeriQuest from August 1995 to December 1995. From April 1993 to December 1993, Dr. Clark was the President and ChiefExecutive Officer of an AmeriQuest subsidiary, CDS Distribution, Inc.  Dr. Clark was the President of EverexSystems, Inc., a supplier of server, workstation, notebook and desktopsolutions from February 1991 to December 1992. From October 1984 to April 1990, Dr. Clark was President and ViceChairman of Ingram Micro, a wholesale distributor of technology products andservices.

* *

*James W. Klingler*joined TROY as Vice President-Finance, Treasurer and Chief Financial Officer onJanuary 14, 2002.  From February 2001****toNovember 2001, he served as Senior Vice President, Business Operations andChief Financial Officer of Trinagy, Inc., a software company that has beenmerged into Hewlett-Packard Company. Mr. Klingler was Vice President, Finance and Administration of TriconexCorporation, a supplier of products, systems and services for safety, criticalcontrol and turbomachinery applications and a subsidiary of Invensys plc, fromFebruary 1999 to February 2001, and Vice President and Chief Financial Officerof Wilshire Technologies Inc., a company that manufactures polyurethaneproducts, from October 1994 to February 1999. In addition, he has held financial management positions with Allergan,Inc., PEPSICO subsidiary Kentucky Fried Chicken Corp., Schering-Plough Corp.and Continental Group, Inc.  A CertifiedManagement Accountant and veteran of the U.S. Air Force, Mr. Klingler holds aB.A. from The Ohio State University and an MBA from the Columbia UniversityGraduate School of Business.

 

(c)           *Compliance with Section 16(a) of the Exchange Act*.

 

Section 16(a) ofthe Securities Exchange Act of 1934, as amended, requires our directors,executive officers, and stockholders holding more than 10% of our outstandingcommon stock, to file with the Securities and Exchange Commission initial reportsof ownership and reports of changes in beneficial ownership of our commonstock.  Executive officers, directorsand greater-than-10% stockholders are required by SEC regulations to furnish uswith copies of all Section 16(a) reports they file.  To our knowledge, based solely on review of the copies of suchreports furnished to us for the period

 

34

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ended November 30, 2002, all Section 16(a) reports required to be filedby our executive officers, directors and greater-than-10% stockholders werefiled on a timely basis.

 

# **Item 11.  EXECUTIVE COMPENSATION.**

 

The following table sets forth the cash and non-cash compensation paid orearned during fiscal 2000, 2001 and 2002 by our Chief Executive Officer and ourthree other executive officers, all of whom received or earned cash andnon-cash salary and bonus of more than $100,000 for fiscal 2002.

 

**Summary Compensation Table**

 
|                               |   |     |       | **Annual Compensation** |       | **Long-Term  Compensation  Awards** |       |                                   |       |
|------------------------------------|--------|----------|------------|-------------------------|------------|-------------------------------------|------------|----------------------------------------|------------|
| **Name and  Principal Position**   |   | **Year** |       | **Salary($)**           |       | **Bonus($)(1)**                     |       | **Other annual  compensation  ($)(2)** |       | **Securities  Underlying  Options(#)** |   | **All other  compensation  ($)(3)** |   |
|                               |   |     | ** ** |                    | ** ** |                                | ** ** |                                   | ** ** |   | ** ** |   | ** ** |
| Patrick J. Dirk                    |   | 2002     |       | $                       | 348,000    |                                | $          | —                                 |       | $ | 2,925 |   | — |   | $ | 6,000 |   |
| *Chairman of  the Board, and*      |   | 2001     |       | 265,000                 |       | —                              |       | 3,075                                  |       | — |   | 5,100 |   |
| *Chief  Executive Officer*         |   | 2000     |       | 250,000                 |       | 66,750                              |       | 3,525                                  |       | — |   | 5,100 |   |
|                               |   |     |       |                    |       |                                |       |                                   |       |   |   |   |   |
| Brian P. Dirk                      |   | 2002     |       | $                       | 214,000    |                                | —     |                                   | $          | 2,475 |   | 100,000 |   | $ | 6,000 |   |
| *Vice  Chairman*                   |   | 2001     |       | 175,000                 |       | —                              |       | 2,475                                  |       | 50,000 |   | 4,797 |   |
| *and Director*                     |   | 2000     |       | 160,000                 |       | 25,000                              |       | 2,775                                  |       | — |   | 5,100 |   |
|                               |   |     |       |                    |       |                                |       |                                   |       |   |   |   |   |
| James W. Klingler* *          |   | 2002     |       | $                       | 152,000    |                                | —     |                                   | —     |   | 80,000 |   | 3,738 |   |
| *Vice  President-Finance, Chief*   |   | 2001     |       | —                  |       | —                              |       | —                                 |       | — |   | — |   |
| *Financial  Officer and Treasurer* |   | 2000     |       | —                  |       | —                              |       | —                                 |       | — |   | — |   |
|                                    |        |          |            |                         |            |                                     |            |                                        |            |  |  |  |  |  |  |  |  |

 

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(1)                                  Figuresfor fiscal year 2000 represent performance bonuses of $66,750, and $25,000 forMessrs. Patrick Dirk and Brian Dirk, respectively.

 

(2)                                  Figuresfor fiscal year 2002 represent $2,925 and $2,475 for automobile usage forMessrs. Patrick Dirk and Brian Dirk, respectively.  Figures for fiscal year 2001 represent $3,075 and $2,475 forautomobile usage for Messrs. Patrick Dirk and Brian Dirk, respectively.  Figures for fiscal year 2000 represent$3,525 and $2,775 for automobile usage for Messrs. Patrick Dirk and Brian Dirk,respectively.

 

(3)                                  Allfigures represent matching contributions under Troy Group’s 401(k) Plan.  We also paid premiums for split-dollar lifeinsurance policies covering Patrick J. Dirk, which amounts we will recover fromthe policies.  As a result of TheSarbanes-Oxley Act of 2002, since July 29, 2002 the Company has not funded theannual premium payments on these policies. See Item 13.”Certain Relationships and Related Transactions.”

 

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**Option Grantsand Exercises**

 

The following tables summarize option grants and exercises during thefiscal year ended November 30, 2002 to or by each of the executive officersnamed in the Summary Compensation Table above, and the potential realizablevalue of the options held by such persons at November 30, 2002.

 

**OptionGrants in Last Fiscal Year**

 
|              |   | **Individual  Grants**                                        |       |                                                                 |       |
|-------------------|--------|---------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Name**          |   | **Number of  securities  underlying options  granted (#)(1)** |       | **Percent of  total  options granted  to employees in  fiscal year** |       | **Exercise  or base  price ($/sh)** |   | **Expiration  date** |   | **Grant date  present  value ($)(2)** |   |
|              |   |                                                          | ** ** |                                                                 | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Patrick J. Dirk   |   | —                                                        |       | —                                                               |       | — |   | — |   | — |   |
|              |   |                                                          |       |                                                                 |       |   |   |   |   |   |   |
| Brian P. Dirk     |   | 100,000                                                       |       | 28.6                                                                 | %          | $ | 4.51 |   | 1/16/07 |   | $ | 176,324 |   |
|              |   |                                                          |       |                                                                 |       |   |   |   |   |   |   |
| James W. Klingler |   | 30,000                                                        |       | 8.6                                                                  | %          | $ | 4.10 |   | 1/13/12 |   | $ | 76,053 |   |
|              |   |                                                          |       |                                                                 |       |   |   |   |   |   |   |
| James W. Klingler |   | 50,000                                                        |       | 14.3                                                                 | %          | $ | 3.62 |   | 3/12/12 |   | $ | 113,643 |   |

 

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(1)                                  Theoptions granted to Mr. Dirk and Mr. Klingler were granted under our 1998 StockOption Plan at a exercise price equal to 110% and 100% , respectively, of theclosing price of one share of our common stock on the date of grant as reportedon the Nasdaq National Market.  Thestock options will become exercisable at the rate of twenty-five percent of thenumber of shares underlying the options on each of the first four anniversariesof the dates of grant.  In the event ofa “change in control,” as defined in the 1998 Plan, the options will becomeimmediately exercisable in full and will remain so for the remainder of theirterm regardless of whether the holder remains in the employ or service of Troy.

 

(2)                                  Representsthe present value of the option granted on the date of grant using theBlack-Scholes option pricing model, which requires the assumption of certainvalues.  In calculating the value shown,we assumed annualized volatility of the price of common stock of 51%, time ofexercise or option life of 5 years, and a risk-free interest rate of 2.00% and2.47%, determined from market information as of the date of grant.  No adjustments were made for thenon-transferability or risk of forfeiture of the option, and, because we havehistorically not paid dividends on common stock, no yield on common stock wasassumed.  There can be no assurance thatthese assumptions will prove true in the future.  The actual value, if any, that an executive may realize willdepend on the excess of the market price of common stock over the exerciseprice on the date the option is exercised, which may vary from the theoreticalvalue indicated in the table.

 

36

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**AggregatedOption Exercises In**

**LastFiscal Year and Fiscal Year-End Option Values**

 
| **Name**          |   | **Shares  acquired on  exercise (#)** |            | **Value  realized  ($)** |              | **Number of securities  underlying unexercised  options at fiscal year end (#)** |   | **Value of unexercised  in-the-money options  at fiscal year end ($)(1)** |   |
|-------------------|--------|---------------------------------------|-----------------|--------------------------|-------------------|----------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|
| **Exercisable**   |   | **Unexercisable**                     | **Exercisable** |                     | **Unexercisable** |
|              |   |                                  |            |                     |              |                                                                             |   |                                                                      |   |   |   |   |   |
| Patrick J. Dirk   |   | —                                |            | —                   |              | —                                                                           |   | —                                                                    |   | — |   | — |   |
|              |   |                                  |            |                     |              |                                                                             |   |                                                                      |   |   |   |   |   |
| Brian P. Dirk     |   | —                                |            | —                   |              | 55,500                                                                           |   | 124,500                                                                   |   | $ | 0 |   | $ | 0 |   |
|              |   |                                  |            |                     |              |                                                                             |   |                                                                      |   |   |   |   |   |
| James W. Klingler |   | —                                |            | —                   |              | 20,000                                                                           |   | 60,000                                                                    |   | $ | 0 |   | $ | 0 |   |

 

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(1)                                  Thevalues indicated are based on the difference between the fair market value ofone share of common stock on November 30, 2002 ($1.83) and the exercise pricesof the respective options, ranging from $3.62 to $6.31 per share.  Options are in-the-money if the market priceof the shares exceeds the option exercise price.

** **

**Management Agreements**

* *

*Messina Non-Competition Agreement*.** **On November 27, 1996, we enteredinto a non-competition agreement with Robert Messina regarding his services asPresident and Chief Operating Officer of Troy Systems International.  Under the terms of this agreement, wegranted Mr. Messina an option to purchase 244,990 shares of common stockat an exercise price of $0.41 per share expiring on November 25, 2006.  This option, which became fully vested uponcompletion of our initial public offering in July 1999, was exercised by Mr.Messina during fiscal 1999.  Ouragreement with Mr. Messina requires him to maintain the confidentiality ofour proprietary information and prohibits him from engaging in competitiveactivity for a three-year period after his termination.

* *

*Messina Separation Agreement andRelease. *On November1, 2001, we entered into a separation agreement and release with Robert Messinain connection with Mr. Messina’s resignation as the President and ChiefOperating Officer and an employee of TROY effective October 25, 2001.  In connection with the separation agreementand release, Mr. Messina received a monthly severance payment for 12 monthswhich totaled $252,000 beginning on November 1, 2001.

* *

*Change in Control Arrangements*.  Under our 1998 Stock Incentive Plan, if a“change in control” of TROY occurs, then, unless the Compensation Committeedecides otherwise either at the time of grant of an incentive award or at anytime thereafter, all options that have been outstanding at least three monthswill become immediately exercisable for the remainder of their terms,regardless of whether the participants to whom such options have been grantedremain the employ or service of TROY or any subsidiary.  Under the terms of their respective optionagreements, all of the options granted to our executive officers will besubject to such accelerated vesting upon a change in control.

 

In addition, upona change in control, the Compensation Committee may pay cash for all or aportion of the outstanding options.  Theamount of cash the participants would receive will equal the excess of the fairmarket value immediately prior to the effective date of such change in controlover the exercise price per share of the options.  The acceleration of the exercisability of options under the Planmay be limited, however, if the acceleration would be subject to an excise taximposed upon “excess parachute payments.”

 

37

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The Plan alsoprovides that if a “change in control” of TROY occurs, then, unless theCompensation Committee decides otherwise either at the time of grant of anincentive award or at any time thereafter:

 

•                  allstock appreciation rights that have been outstanding at least three months willbecome immediately exercisable in full and will remain exercisable for theremainder of their terms, regardless of whether the participant remains in theemploy or service of TROY or any subsidiary;

 

•                  alloutstanding restricted stock awards will become immediately fully vested andnon-forfeitable; and

 

•                  alloutstanding performance units and stock bonuses will vest and/or continue tovest in the manner determined by the Compensation Committee and reflected inthe award agreement.

 

Under the Plan, a“change in control” will include any of the following:

 

•                  thesale or other disposition of substantially all of our assets;

 

•                  theapproval by our stockholders of a Plan or proposal for the liquidation ordissolution of TROY;

 

•                  amerger or consolidation to which we are a party if our stockholders immediatelyprior to the merger or consolidation beneficially own, immediately after themerger or consolidation, securities of the surviving corporation representing(A) more than 50%, but not more than 80%, of the combined voting power of thesurviving corporation’s then outstanding securities unless such transaction wasapproved in advance by the “continuity directors,” which are the directors asof the effective date of the Plan or any persons who subsequently becomedirectors and whose election or nomination was approved by a majority vote ofthe continuity directors, or (B) 50% or less of the combined voting power ofthe surviving corporation’s then outstanding securities, regardless of anyapproval by the continuity directors;

 

•                  anyperson becoming, after the effective date of the Plan, the beneficial owner of(A) 20% or more, but less than 50%, of the combined voting power of ouroutstanding securities, unless the transaction was approved in advance by thecontinuity directors, or (B) 50% or more of the combined voting power of ouroutstanding securities, regardless of any approval by the continuity directors;or

 

•                  thecontinuity directors cease for any reason to constitute at least a majority ofour Board.

 

Notwithstandinganything in the foregoing to the contrary, no change in control will be deemedto have occurred for purposes of the Plan by virtue of certain transfers amongthe members of  Patrick J. Dirk’s familyor family trusts.

 

**Compensation Committee Report OnExecutive Compensation**

 

The CompensationCommittee reviews general programs of compensation and benefits for all employeesand makes recommendations to our Board of Directors concerning compensationpaid to our executive officers, directors and certain key employees.  Compensation paid to these individuals isreviewed and set annually by the Compensation Committee to coincide with ourfiscal year.

 

38

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The CompensationCommittee also administers our stock-based compensation plans, including our1998 Stock Incentive Plan, which allows the Compensation Committee to grant incentivestock options, non-statutory stock options, restricted stock awards, stockappreciation rights, performance units and stock bonuses to eligible keyemployees, officers, directors and consultants.

*** ***

***Compensation Philosophy and Objectives***.  The overall philosophy underlying thedecisions and recommendations of the Compensation Committee is to recognize andreward results and achievement at both the individual and company level bylinking compensation to such achievement. Consistent with this philosophy, the Compensation Committee has set thefollowing objectives for our executive compensation program:

 

•                  Encouragethe achievement of desired individual and company performance goals byrewarding such achievements.

 

•                  Providea program of compensation that is competitive with comparable companies toenable us to attract and retain key executive talent.

 

•                  Alignthe interests of our executives with the interests of our stockholders bylinking compensation to company performance and ensuring that our executiveshave opportunities for long-term stock ownership.

 

In making itsrecommendations to our Board of Directors, the Compensation Committee considersfactors such as company performance, both in isolation and in comparison tocompanies of comparable profitability, complexity and size; the individualperformance of each executive officer; our historical compensation levels; theoverall competitive environment for executives and the level of compensationnecessary to attract and retain the level of key executive talent that wedesire.  In analyzing these factors, theCompensation Committee may from time to time review competitive compensationdata gathered in comparative surveys or collected by independent consultants.

 

***Executive Compensation Program Components****.*  Our executive compensation policies arerecommended and administered by the Compensation Committee of the Board ofDirectors.  The Compensation Committeeis currently composed of three independent, outside directors

 

Since the date ofour initial public offering, our Compensation Committee has established anexecutive compensation program consisting of base salary, annual cash bonuscompensation, long-term incentive opportunities under the 1998 Plan and otherbenefits.  Each element of thiscompensation program is discussed in greater detail below.

 

*Base Salary. *Each executive officer’sbase salary is determined annually by the Compensation Committee and ratifiedby our Board of Directors after considering the compensation levels ofexecutives at comparable companies in our industry, the potential impact of theindividual on company performance, the level of skill, responsibility andexperience required by the individual’s position and the other factorsdescribed above.  In evaluatingcomparable company compensation, the Compensation Committee places particularemphasis on data for companies with revenues similar to our forecasted revenuesfor the relevant fiscal year.  The basesalary for our Chief Executive Officer, Patrick J. Dirk, was increased from $265,000in fiscal year 2001 to $350,000 in fiscal year 2002.  In determining Mr. Dirk’s base salary, the Compensation Committeeconsidered all of the criteria discussed above, as well as Mr. Dirk’s agreementto assume the duties of President and Chief Operating Officer in addition tohis existing responsibilities as Chairman of the Board and Chief ExecutiveOfficer.

 

39

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*Annual Cash Bonuses. *The Compensation Committeeutilizes annual cash bonuses to provide a direct financial incentive to theCompany’s executive officers.  Under theexecutive officer bonus program administered by the Compensation Committee,each executive is eligible to receive bonus, subject to achievement ofspecified company goals.  No bonuseswere paid for fiscal 2001.  Bonuses forfiscal 2002 for all executive officers will be tied to the achievement ofoverall revenues and profitability of TROY.

 

*Long-Term IncentiveCompensation. *TheCompensation Committee makes long-term incentive compensation available to ourexecutive officers through its administration of the 1998 Plan, as discussedabove.  From time to time theCompensation Committee evaluates equity ownership by our executive officers andmay grant stock-based compensation under the 1998 Plan in order to reward suchexecutives for their contributions to achievement of company objectives and tofurther align their interests with those of our stockholders.  During fiscal 2002, 180,000 options weregranted to the executive officers.  Dueto his significant stockholdings Mr. Dirk was not granted additionalstock-based compensation in fiscal 2002.

 

*Other Benefits.*  In addition to the compensation describedabove, our executive officers receive benefits under our insurance, 401(k) andemployee stock purchase plans, each of which is generally available to ourother employees.  We also compensatesome of our executive officers for automobile expense.

 

***Section 162(m)****. *Section 162(m) of the Internal Revenue Code of 1986 limitsour ability to deduct certain compensation in excess of $1 million paid to ourchief executive officer and each of our four other most highly compensatedexecutives.  In 2002, we did not pay“compensation” within the meaning of Section 162(m) in excess of $1 million toour executive officers, and we do not believe that we will do so in the nearfuture.  As a result, we have notestablished a policy for qualifying compensation paid to our executive officersfor deductibility under Section 162(m), but will formulate such a policy ifcompensation levels ever approach $1 million.

 
|   | *Compensation  Committee* |
|--------|---------------------------|
|   |                      |
|   | Norman B. Keider          |
|   | John B. Zaepfel           |
|   | Dr. Harold L. Clark       |

 

40

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**ComparativeStock Performance**

 

The graph belowcompares the cumulative total stockholder return on our common stock to thetotal cumulative return on the Nasdaq Market Index and an industry index basedon Standard Industrial Code 3570-3579 (Computer and Office Equipment) duringthe period from our initial public offering on July 21, 1999 to November 30,2002.  The graph assumes a $100investment in common stock, the Nasdaq Market Index and the industry index onJuly 21, 1999 and the reinvestment of all dividends.

 

 

41

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# **Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT.**

 

The followingtable sets forth, as of February 28, 2003, information regarding the beneficialownership of our common stock by (a) each stockholder who is known by us to ownbeneficially more than 5% of the outstanding common stock, (b) each director,(c) each executive officer named in the Summary Compensation Table and (d) allour executive officers and directors as a group.

 

Unless otherwisenoted, each of the stockholders listed in the table possesses sole voting andinvestment power with respect to the shares indicated.  Shares not outstanding but deemedbeneficially owned by virtue of the right of a person or member of a group toacquire them within 60 days are treated as outstanding only when determiningthe amount and percent owned by such person or group.  As of February 28, 2003, there were 10,649,092 shares of commonstock outstanding.

** **

|                                                              |   | **Shares of Common Stock  Beneficially Owned** | ** ** |
|-------------------------------------------------------------------|--------|------------------------------------------------|------------|
| **Name of Beneficial Owner**                                      |   | **Amount**                                     | ** ** | **Percent  of Class** | ** ** |
|                                                              |   |                                           |       |   |   |
| Patrick J. Dirk(1)                                                |   | 5,679,857                                      | (2)        | 53.3 | % |
| Mary J. Dirk(1)                                                   |   | 5,679,857                                      | (2)        | 53.3 | % |
| Brian P. Dirk                                                     |   | 538,719                                        | (3)        | 5.1 | % |
| James W. Klingler                                                 |   | 20,000                                         | (4)        |   | * |
| Norman B. Keider                                                  |   | 50,000                                         | (5)        |   | * |
| John B. Zaepfel                                                   |   | 50,000                                         | (6)        |   | * |
| Dr. Harold L. Clark                                               |   | 50,000                                         | (7)        |   | * |
| All directors and executive officers as a group  (6 persons) |   | 6,388,576                                      | (8)        | 60.0 | % |

 

----

*                                         Lessthan 1% of the outstanding shares.

 

(1)                                  Address:  2331 South Pullman Street, Santa Ana,California 92705.

 

(2)                                  Includes(i) 5,650,000 shares of common stock held by Patrick J. and  Mary J. Dirk as trustees under The DirkFamily Trust UTD March 6, 1990 and (ii) 29,857 shares of common stock held byThe Dirk Foundation of which Patrick J. and Mary J. Dirk disclaim beneficialownership over such shares.

 

(3)                                  Mr.Brian Dirk’s beneficial ownership includes 46,785 shares that Mr. Brian Dirkholds as a trustee under the Dirk 1998 Alaska Trust and 55,500 shares of commonstock issuable upon exercise of stock options.

 

(4)                                  Mr.Klingler’s beneficial ownership includes shares of common stock issuable uponexercise of stock options.

 

(5)                                  Mr.Keider’s beneficial ownership includes shares of common stock issuable uponexercise of stock options.  Mr. Keider’saddress is 7569 Caminito Avola, LaJolla, CA 92037.

 

(6)                                  Mr.Zaepfel’s beneficial ownership includes shares of common stock issuable uponexercise of stock options..  Mr.Zaepfel’s address is 500 Birch Street, Newport Beach, CA  92660.

 

42

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(7)                                  Dr.Clark’s beneficial ownership includes shares of common stock issuable uponexercise of stock options.  Dr. Clark’saddress is 38388 Rock Creek Circle, Temecula, CA  92592.

 

(8)                                  Includes225,500 shares of common stock that directors and executive officers have theright to acquire within 60 days upon the exercise of stock options.

** **

**EquityCompensation Plan Information**

 

The following table sets forth information as ofNovember 30, 2002 about shares of our common stock outstanding and availablefor issuance under our existing equity compensation plans.  Options granted in the future under theplans are within the discretion of our Compensation Committee and thereforecannot be ascertained at this time.

 
|                                                        |   | **(a)**                                                                                              |   | **(b)**                                                                            |   | **(c)**                                                                                                                                                  |      |
|-------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| **Plan Category**                                           |   | **Number of  Securities  to be Issued Upon  Exercise of  Outstanding Options,  Warrants and Rights** |   | **Weighted-Average  Exercise Price of  Outstanding Options,  Warrants and Rights** |   | **Number of  Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans (excluding securities  reflected in column (a))(1)** |      |
| Equity  compensation plans approved by security holders     |   | 1,336,000                                                                                            |   | $                                                                                  | 5.95   |                                                                                                                                                     | 1,487,078 |   |
| Equity  compensation plans not approved by security holders |   | 131,666                                                                                              |   | 4.16                                                                               |   | —                                                                                                                                                   |      |
| **Total**                                                   |   | 1,467,666                                                                                            |   | $                                                                                  | 5.79   |                                                                                                                                                     | 1,487,078 |   |

 

----

(1) Includes 1,364,000shares available for issuance under our 1998 Stock Option Plan and 123,078shares available for issuance under our 1998 Employee Stock Purchase Plan.

 

# **Item 13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS.**

 

Prior to April1998, Troy Group and its subsidiary, Troy Group Systems International, were100% beneficially owned by Patrick J. and Mary J. Dirk as trustees under TheDirk Family Trust UTD March 6, 1990, the trustee of The Dirk 1997 EducationTrust, the trustees of the Dirk 1998 Alaska Trust, Brian P. Dirk and Patrick J.Dirk’s other three children.  Forconvenience, we refer to each of these individuals and trusts collectively asthe Dirk stockholders.

 

We lease a totalof 77,000 square feet at our West Virginia facility from Dirk Investments,Inc.  Dirk Investments is wholly-ownedby the Dirk stockholders.  This leaseexpires on March 31, 2008 and is automatically renewable for successivesix-year terms unless either party gives notice to cancel.  It provides for rent, of approximately$22,500 per month, which can be increased up to 6% per year.  Total rental payments made by us for thefiscal year ended November 30, 2002 were approximately $270,000.

 

We and the Dirkstockholders are also parties to a Tax Agreement Relating to S Corporation Distributions.  Under this agreement, we have agreed toindemnify the Dirk stockholders for any adjustments causing an increase intheir federal and state income tax liability, including interest and penalties,related to tax years prior to October 30, 1998.  Subject to certain limitations, this agreement also provides thatthe Dirk stockholders will reimburse us for any amounts refunded to them as aresult of the loss of the S corporation status of Troy Group or Troy GroupSystems.  Any payment made by us to theDirk stockholders pursuant to this agreement may be considered by the InternalRevenue Service or

 

43

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state taxing authorities to be nondeductible by Troy Group or TroyGroup Systems for income tax purposes.

 

We entered into asplit dollar life insurance arrangement whereby we pay the underlying lifeinsurance premiums on policies covering Patrick J. Dirk and his spouse as acondition of Mr. Dirk’s continued employment with us.  Pursuant to this arrangement, we made quarterly payments of$100,000 for a $23 million dollar policy, and quarterly payments of $8,750 fora $7 million policy.  We will recoverall split-dollar premiums paid by us from the policies or the owners of thepolicies.  We have an unsecuredreceivable from Mr. Dirk’s heirs for the return of the  premiums paid under these policies.  Mr. Dirk’s heirs, including Brian Dirk whois a director and executive officer of Troy, are third-party beneficiaries ofthese policies.  In addition, in 1999,we entered into a split dollar insurance arrangement whereby we paid theunderlying life insurance premiums on a policies covering Patrick J. Dirk whosespouse is the beneficiary.  Pursuant tothis arrangement, we made quarterly payments of $32,000 for a $2 million faceamount policy which carries a death benefit of $8 million and semi-annualpayments of $10,850 for a $1 million policy. We will recover all split-dollar premiums paid by us from the policies.  We have an unsecured receivable, in the formof a split-dollar agreement, from Mr. Dirk for the return of the premiums paidunder these policies.  TheSarbanes-Oxley Act of 2002 prohibits extensions of credit in the form of apersonal loan to certain company insiders after July 29, 2002.  As a result, since July 29, 2002 the Companyhas not funded the annual premium payments on the policies.  If the SEC issues new regulations or otherguidance that causes us to reevaluate our position, we may demand payment on thenote and terminate our participation in these arrangements. At November 30,2002, we recorded $2,123,000 as an asset that represents the policy premiumspaid to date.

 

On November 5,2002, TROY Group, Inc. announced that a Special Committee of the Board ofDirectors had been formed to consider a proposal by Patrick Dirk and his familymembers to purchase the interests of the minority stockholders of TROY.  As of the filing of this report, the partieshave not entered into a definitive agreement regarding such acquisition.

 

44

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**PART IV**

** **

----

** **

# **Item 14.  CONTROLS AND PROCEDURES**

 

Within the 90 daysprior to the date of this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and our Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures pursuant toRules 13a-14 and 13a-15 under the Securities Exchange Act of 1934, as amended.  Based upon that evaluation, our ChiefExecutive Officer and our Chief Financial Officer concluded that with theexception of the item listed below, our disclosure controls and procedures areeffective.

 

On October 15,2002, we issued a press release announcing that the filing of our Form 10-Q forthe fiscal quarter ended August 31, 2002 would be delayed. We had conductedphysical inventory counts and discovered certain inventory shortfalls and otheradjustments. We delayed the filing of our Form 10-Q for the fiscal quarterended August 31, 2002 in order to give us sufficient time to review the causesof such inventory adjustments and to determine if any of the financialstatements for prior periods would need to be restated.  We also reviewed our inventory accountingcontrols and determined that there were certain material weaknesses.  As a result, we have taken a number ofcorrective measures to address these weaknesses.  Our Irvine and Boise facilities have now been closed andconsolidated into our Wheeling facility, where the employees have moreexperience in using our materials management system.  In addition, we have implemented additional training proceduresto ensure that this continues to be the case, have hired personnel with moreexperience in managing the accounting function in a manufacturing environment,and currently expect to install a new ERP system by the end of fiscal year2003.  The Company also intends toconduct quarterly physical inventory counts until it is satisfied that its systemsare operating properly.  There were noother significant changes in our internal controls or in other factors thatcould significantly affect these controls subsequent to the date of ourevaluation.

 

# **Item 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, ANDREPORTS ON FORM 8-K**

 

(a)                                  *List of documentsfiled as part of this report:*

 

(1)                                  *FinancialStatements:*

 

The followingfinancial statements are included in this report on the pages indicated:

 
| Independent auditor’s  report                                                            |
|-----------------------------------------------------------------------------------------------|
| Consolidated balance sheets  as of  November 30, 2002 and 2001                                |
| Consolidated  statements of operations for the years ended  November 30, 2002, 2001 and 2000  |
| Consolidated statements  of cash flows for the years ended  November 30, 2002, 2001 and 2000  |
| Consolidated  statements of stockholders’ equity as of  November 30, 2002, 2001 and 2000 |
| Notes to  consolidated financial statements                                                   |

 

45

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(2)            *Financial Statement Schedules:*

 

All financial statementschedules have been omitted because the required information is included in ourconsolidated financial statements or the related notes, or is not applicable.

 

(3)                                  *Exhibits*

 

The exhibits to thisAnnual Report on Form 10-K are listed in the Exhibit Index contained on pagesE-1 through E-5 of this report.

 

We will furnish a copy ofany exhibit to a stockholder who requests a copy in writing and pays a fee of$25.00 per exhibit.  Requests should besent to:  James W. Klingler, ChiefFinancial Officer, Troy Group, Inc, 2331 South Pullman Street, Santa Ana,California 92705.

 

The following is a listof each management contract or compensatory plan or arrangement required to befiled as an exhibit to this Annual Report on Form 10-K pursuant to Item 15(c):

 

A.                                   1996Stock Option Plan (incorporated by reference to Exhibit 10.7 to Troy Group’sRegistration Statement on Form S-1 (File No. 333-51523)).

 

B.                                     1998Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.2 toTroy Group’s Form 10-Q for the quarter ended August 31, 2000 (File No.  000-24413)).

 

C.                                     1998Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.9 to TroyGroup’s Registration Statement on Form S-1 (File No.  333-51523)).

 

D.                                    Formof Indemnification Agreement for directors and executive officers of Troy Group(incorporated by reference to Exhibit 10.14 to Troy Group’s RegistrationStatement on Form S-1 (File No. 333-51523)).

 

(b)                                 *Reportson Form 8-K:*

 

On January 21, 2003, wefiled a Current Report on Form 8-K under Item 4 regarding the decision by ourBoard of Directors to dismiss KPMG LLP as our independent public accountants.

 

On February 7, 2003, wefiled a Current Report on Form 8-K under Item 4 regarding our engagement ofMcGladrey & Pullen LLP as our independent public accountants.

 

(c)                                  *Exhibits:*

 

The response to thisportion of Item 15 is included as a separate section of this Annual Report onForm 10-K.

 

(d)                                 *FinancialStatement Schedules:*

 

The response to thisportion of Item 15 is included as a separate section of this Annual Report onForm 10-K.

 

46

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**INDEPENDENT AUDITOR’S REPORT**

 

To the Board of Directors

Troy Group, Inc.

Santa Ana,California

 

We have auditedthe accompanying consolidated balance sheets of Troy Group, Inc. andsubsidiaries as of November 30, 2002 and 2001, and the related consolidatedstatements of operations, cash flows and stockholders’ equity for each of thethree years in the period ended November 30, 2002.  These financial statements are the responsibility of theCompany’s management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates of America.  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Troy Group, Inc. and subsidiariesas of November 30, 2002 and 2001, and the results of their operations and theircash flows for each of the three years in the period ended November 30,2002 in conformity with accounting principles generally accepted in the UnitedStates of America.

 
|   | McGLADREY &  PULLEN, LLP    |
|--------|---------------------------------|
|   |                            |
|   | /s/ McGladrey & Pullen, LLP |

 

 

Anaheim,California

 

February 21, 2003

 

F-1

----

 

**TROY GROUP, INC.**

** **

**CONSOLIDATED BALANCE SHEETS**
|                                                                                                                          |   | **November  30,** |       |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|
|                                                                                                                          |   | **2001**          |       | **2002** |   |
| **ASSETS**                                                                                                                    |   |              |       |   |   |
|                                                                                                                          |   |              |       |   |   |
| Current assets:                                                                                                               |   |              |       |   |   |
| Cash and cash  equivalents                                                                                                    |   | $                 | 1,210,000  |   | $ | 6,615,000 |   |
| Investment in  available-for-sale securities                                                                                  |   | 5,181,000         |       | 497,000 |   |
| Accounts  receivable, less allowance for doubtful accounts 2001 $1,130,000; 2002  $884,000                                    |   | 9,713,000         |       | 9,227,000 |   |
| Income tax  refund receivable                                                                                                 |   | 1,059,000         |       | 1,076,000 |   |
| Inventories                                                                                                                   |   | 9,251,000         |       | 5,540,000 |   |
| Prepaid expenses  and other                                                                                                   |   | 358,000           |       | 440,000 |   |
| Deferred tax  assets                                                                                                          |   | 2,480,000         |       | 3,715,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Total current assets                                                                                                          |   | 29,252,000        |       | 27,110,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Equipment and  leasehold improvements, net                                                                                    |   | 2,529,000         |       | 2,039,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Other assets,  including receivable from stockholders 2001 $1,666,000; 2002 $2,123,000                                        |   | 5,226,000         |       | 4,390,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Total assets                                                                                                                  |   | $                 | 37,007,000 |   | $ | 33,539,000 |   |
|                                                                                                                          |   |              |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                |   |              |       |   |   |
|                                                                                                                          |   |              |       |   |   |
| Current  liabilities:                                                                                                         |   |              |       |   |   |
| Current portion  of long-term debt                                                                                            |   | $                 | 70,000     |   | $ | 73,000 |   |
| Accounts payable                                                                                                              |   | 4,418,000         |       | 4,138,000 |   |
| Accrued expenses                                                                                                              |   | 2,456,000         |       | 2,218,000 |   |
| Deferred revenue                                                                                                              |   | 1,138,000         |       | 1,364,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Total current  liabilities                                                                                                    |   | 8,082,000         |       | 7,793,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Long-term debt,  net of current portion                                                                                       |   | 193,000           |       | 120,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Commitments and  contingencies                                                                                                |   |              |       |   |   |
|                                                                                                                          |   |              |       |   |   |
| Stockholders’  equity:                                                                                                   |   |              |       |   |   |
| Preferred stock,  no par value, authorized 5,000,000 shares; issued none                                                      |   | —            |       | — |   |
| Common stock,  par value $.01 per share; authorized 50,000,000 shares; issued 2001  10,921,032 shares; 2002 10,969,657 shares |   | 109,000           |       | 110,000 |   |
| Additional  paid-in capital                                                                                                   |   | 20,966,000        |       | 21,113,000 |   |
| Retained  earnings                                                                                                            |   | 8,753,000         |       | 5,578,000 |   |
|                                                                                                                          |   | 29,828,000        |       | 26,801,000 |   |
| Less cost of  treasury stock 2001 295,320; 2002 320,565 shares                                                                |   | 1,096,000         |       | 1,175,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Total  stockholders’ equity                                                                                              |   | 28,732,000        |       | 25,626,000 |   |
|                                                                                                                          |   |              |       |   |   |
| Total  liabilities and stockholders’ equity                                                                              |   | $                 | 37,007,000 |   | $ | 33,539,000 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

F-2

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**TROY GROUP, INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
|                                                                                    |   | **Fiscal  Years Ended November 30,** |       |
|-----------------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                                    |   | **2000**                             |       | **2001** |   | **2002** |   |
|                                                                                    |   |                                 |       |   |   |   |   |
| Net sales                                                                               |   | $                                    | 52,310,000 |   | $ | 49,218,000 |   | $ | 54,998,000 |   |
|                                                                                    |   |                                 |       |   |   |   |   |
| Cost of goods  sold (including$270,000 in rent paid to majority stockholders each year) |   | 30,053,000                           |       | 30,766,000 |   | 38,011,000 |   |
|                                                                                    |   |                                 |       |   |   |   |   |
| Gross profit                                                                            |   | 22,257,000                           |       | 18,452,000 |   | 16,987,000 |   |
|                                                                                    |   |                                 |       |   |   |   |   |
| Operating  expenses:                                                                    |   |                                 |       |   |   |   |   |
| Selling, general  and administrative                                                    |   | 14,189,000                           |       | 15,681,000 |   | 14,908,000 |   |
| Research and  development                                                               |   | 4,372,000                            |       | 6,027,000 |   | 6,872,000 |   |
| Amortization of  intangible assets                                                      |   | 983,000                              |       | 1,235,000 |   | 131,000 |   |
| Impairment of  long-lived and intangible assets                                         |   | —                               |       | 5,634,000 |   | — |   |
|                                                                                    |   | 19,544,000                           |       | 28,577,000 |   | 21,911,000 |   |
|                                                                                    |   |                                 |       |   |   |   |   |
| Operating income  (loss)                                                                |   | 2,713,000                            |       | (10,125,000 | ) | (4,924,000 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Interest income                                                                         |   | 865,000                              |       | 515,000 |   | 101,000 |   |
| Interest expense                                                                        |   | (19,000                              | )          | (138,000 | ) | (34,000 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Income  (loss)  before income taxes (credit)                                       |   | 3,559,000                            |       | (9,748,000 | ) | (4,857,000 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Provision for  income taxes (credit)                                                    |   | 1,152,000                            |       | (3,803,000 | ) | (1,682,000 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Net income  (loss)                                                                      |   | $                                    | 2,407,000  |   | $ | (5,945,000 | ) | $ | (3,175,000 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Net income  (loss) per share:                                                           |   |                                 |       |   |   |   |   |
| Basic                                                                                   |   | $                                    | 0.22       |   | $ | (0.55 | ) | $ | (0.30 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Diluted                                                                                 |   | $                                    | 0.21       |   | $ | (0.55 | ) | $ | (0.30 | ) |
|                                                                                    |   |                                 |       |   |   |   |   |
| Weighted average  shares outstanding:                                                   |   |                                 |       |   |   |   |   |
| Basic                                                                                   |   | 10,832,000                           |       | 10,775,000 |   | 10,647,000 |   |
|                                                                                    |   |                                 |       |   |   |   |   |
| Diluted                                                                                 |   | 11,369,000                           |       | 10,775,000 |   | 10,647,000 |   |

 

See Notes to ConsolidatedFinancial Statements

 

F-3

----

 

**TROY GROUP, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**
|                                                                                    |   | **Fiscal  Years Ended November 30,** |      |
|-----------------------------------------------------------------------------------------|--------|--------------------------------------|-----------|
|                                                                                    |   | **2000**                             |      | **2001** |   | **2002** |   |
| Cash flows from  operating activities:                                                  |   |                                 |      |   |   |   |   |
| Net income  (loss)                                                                      |   | $                                    | 2,407,000 |   | $ | (5,945,000 | ) | $ | (3,175,000 | ) |
| Adjustments to  reconcile net income(loss)to net cash provided by operating activities: |   |                                 |      |   |   |   |   |
| Depreciation and  amortization                                                          |   | 1,645,000                            |      | 2,013,000 |   | 994,000 |   |
| Amortization of  capitalized software                                                   |   | 35,000                               |      | 46,000 |   | 1,140,000 |   |
| Impairment of  long-lived assets                                                        |   | —                               |      | 5,634,000 |   | — |   |
| Provision for  (recovery of) doubtful accounts                                          |   | 536,000                              |      | 953,000 |   | (11,000 | ) |
| Common stock  warrants issued for services                                              |   | 120,000                              |      | — |   | — |   |
| Accretion of  investment discounts, net                                                 |   | (21,000                              | )         | (333,000 | ) | (66,000 | ) |
| Deferred taxes                                                                          |   | (283,000                             | )         | (2,218,000 | ) | (1,331,000 | ) |
| Changes in working  capital components, net of effects from acquisition of companies:   |   |                                 |      |   |   |   |   |
| (Increase)  decrease in:                                                                |   |                                 |      |   |   |   |   |
| Accounts  receivable                                                                    |   | 1,992,000                            |      | (186,000 | ) | 497,000 |   |
| Income tax  refund receivable                                                           |   | (256,000                             | )         | (584,000 | ) | (17,000 | ) |
| Inventories                                                                             |   | (1,160,000                           | )         | (1,409,000 | ) | 3,711,000 |   |
| Prepaid expenses  and other                                                             |   | (426,000                             | )         | 209,000 |   | (82,000 | ) |
| Increase  (decrease) in:                                                                |   |                                 |      |   |   |   |   |
| Accounts payable                                                                        |   | (71,000                              | )         | 1,994,000 |   | (280,000 | ) |
| Accrued expenses                                                                        |   | 132,000                              |      | (329,000 | ) | (238,000 | ) |
| Income taxes  payable                                                                   |   | (1,208,000                           | )         | — |   | — |   |
| Deferred revenue                                                                        |   | (22,000                              | )         | 918,000 |   | 226,000 |   |
|                                                                                    |   |                                 |      |   |   |   |   |
| Net cash  provided by operating activities                                              |   | 3,420,000                            |      | 763,000 |   | 1,368,000 |   |
|                                                                                    |   |                                 |      |   |   |   |   |
| Cash flows from  investing activities:                                                  |   |                                 |      |   |   |   |   |
| Acquisition of  companies                                                               |   | (3,240,000                           | )         | (2,051,000 | ) | — |   |
| Purchase of  available-for-sale securities                                              |   | (15,766,000                          | )         | (5,111,000 | ) | (1,999,000 | ) |
| Maturities of  available-for-sale securities                                            |   | 13,481,000                           |      | 10,215,000 |   | 6,749,000 |   |
| Purchase of  equipment and leasehold improvements                                       |   | (759,000                             | )         | (1,221,000 | ) | (374,000 | ) |
| (Increase) in  other assets                                                             |   | (970,000                             | )         | (1,615,000 | ) | (338,000 | ) |
|                                                                                    |   |                                 |      |   |   |   |   |
| Net  cash provided by  (used in) investing  activities                             |   | (7,254,000                           | )         | 217,000 |   | 4,038,000 |   |
|                                                                                    |   |                                 |      |   |   |   |   |
| Cash flows from  financing activities:                                                  |   |                                 |      |   |   |   |   |
| Principal payments  on debt                                                             |   | (289,000                             | )         | (67,000 | ) | (70,000 | ) |
| Proceeds from  issuance of common stock                                                 |   | 575,000                              |      | 158,000 |   | 148,000 |   |
| Purchase of  treasury stock                                                             |   | —                               |      | (1,096,000 | ) | (79,000 | ) |
|                                                                                    |   |                                 |      |   |   |   |   |
| Net cash  provided by (used in) financing activities                                    |   | 286,000                              |      | (1,005,000 | ) | (1,000 | ) |
|                                                                                    |   |                                 |      |   |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                   |   | (3,548,000                           | )         | (25,000 | ) | 5,405,000 |   |
|                                                                                    |   |                                 |      |   |   |   |   |
| Cash and cash  equivalents, beginning of period                                         |   | 4,783,000                            |      | 1,235,000 |   | 1,210,000 |   |
|                                                                                    |   |                                 |      |   |   |   |   |
| Cash and cash  equivalents, end of period                                               |   | $                                    | 1,235,000 |   | $ | 1,210,000 |   | $ | 6,615,000 |   |

 

See Notes to ConsolidatedFinancial Statements

 

F-4

----

 

**TROY GROUP, INC.**

** **

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**
|                                                         |   | **Common  Stock** |                  | **Additional  Paid-in  Capital** |       | **Treasury  Stock** |   | **Retained  Earnings** |   | **Total**  |   |
|--------------------------------------------------------------|--------|-------------------|-----------------------|----------------------------------|------------|---------------------|--------|------------------------|--------|------------|--------|
| **Number  of Shares**                                        |   | **Amount**        | **Number  of Shares** |                             | **Amount** |
|                                                         |   |              |                  |                             |       |                |   |                   |   |       |   |   |   |   |   |
| Balance,  November 30, 1999                                  |   | 10,663,941        |                  | $                                | 107,000    |                | $      | 17,397,000             |   | —     |   | $ | — |   | $ | 12,291,000 |   | $ | 29,795,000 |   |
| Issuance of  common stock for acquisitions                   |   | 97,040            |                  | 1,000                            |       | 1,863,000           |   | —                 |   | —     |   | — |   | 1,864,000 |   |
| Issuance of  common stock for employee stock purchase plan   |   | 14,654            |                  | —                           |       | 76,000              |   | —                 |   | —     |   | — |   | 76,000 |   |
| Common stock  options and warrants exercised                 |   | 105,129           |                  | 1,000                            |       | 497,000             |   | —                 |   | —     |   | — |   | 498,000 |   |
| Issuance of  common stock warrants                           |   | —            |                  | —                           |       | 755,000             |   | —                 |   | —     |   | — |   | 755,000 |   |
| Tax benefit from  disqualifying disposition of stock options |   | —            |                  | —                           |       | 220,000             |   | —                 |   | —     |   | — |   | 220,000 |   |
| Net income                                                   |   | —            |                  | —                           |       | —              |   | —                 |   | —     |   | 2,407,000 |   | 2,407,000 |   |
|                                                         |   |              |                  |                             |       |                |   |                   |   |       |   |   |   |   |   |
| Balance,  November 30, 2000                                  |   | 10,880,764        |                  | 109,000                          |       | 20,808,000          |   | —                 |   | —     |   | 14,698,000 |   | 35,615,000 |   |
| Issuance of  common stock for employee stock purchase plan   |   | 40,268            |                  | —                           |       | 158,000             |   | —                 |   | —     |   | — |   | 158,000 |   |
| Purchase of common  stock for the treasury                   |   | —            |                  | —                           |       | —              |   | 295,320                |   | (1,096,000 | )      | — |   | (1,096,000 | ) |
| Net (loss)                                                   |   | —            |                  | —                           |       | —              |   | —                 |   | —     |   | (5,945,000 | ) | (5,945,000 | ) |
|                                                         |   |              |                  |                             |       |                |   |                   |   |       |   |   |   |   |   |
| Balance,  November 30, 2001                                  |   | 10,921,032        |                  | 109,000                          |       | 20,966,000          |   | 295,320                |   | (1,096,000 | )      | 8,753,000 |   | 28,732,000 |   |
| Issuance of  common stock for employee stock purchase plan   |   | 38,625            |                  | 1,000                            |       | 118,000             |   | —                 |   | —     |   | — |   | 119,000 |   |
| Common stock  options exercised                              |   | 10,000            |                  | —                           |       | 29,000              |   | —                 |   | —     |   | — |   | 29,000 |   |
| Purchase of  common stock for the treasury                   |   | —            |                  | —                           |       | —              |   | 25,245                 |   | (79,000    | )      | — |   | (79,000 | ) |
| Net (loss)                                                   |   | —            |                  | —                           |       | —              |   | —                 |   | —     |   | (3,175,000 | ) | (3,175,000 | ) |
|                                                         |   |              |                  |                             |       |                |   |                   |   |       |   |   |   |   |   |
| Balance,  November 30, 2002                                  |   | 10,969,657        |                  | $                                | 110,000    |                | $      | 21,113,000             |   | 320,565    |   | $ | (1,175,000 | ) | $ | 5,578,000 |   | $ | 25,626,000 |   |

 

See Notes to ConsolidatedFinancial Statements

 

F-5

----

 

**TROY GROUP, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1.  Nature of Business and Significant Accounting Policies**

 

*Nature of business*

 

TROY Group, Inc.is a worldwide provider of enterprise output solutions.  For the past three years the Compay has beenexpanding beyond its core business in digital check printing systems andrelated consumables by developing electronic payment systems and wired andwireless networking solutions.  TheCompany markets its products to over 5000 active customers around the worldthrough a direct sales force and a network of distributors and value addedresellers.  Most of this new productexpansion was accomplished through the acquisition and further investment infive small technology companies.  Theseacquisitions have been organized under two reportable business segments:  Security Printing Solutions (previously TROYSystems) and Wireless and Connectivity Solutions (previously TROY Wireless).

 

A summary of oursignificant accounting policies follows:

* *

*Use of estimates*

 

The preparation offinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

The Company’soperations are affected by numerous factors including market acceptance,changes in technologies and new laws and government regulations andpolicies.  The Company cannot predictwhat impact, if any, the occurrence of these or other events might have on ouroperations.  Significant estimates andassumptions made by management are used for, but not limited to, the allowancefor doubtful accounts, the reserve for slow moving or obsolete inventories,thefair value of long-lived and intangible assets, and the realizability of thedeferred tax assets which are subject to having adequate future taxable income.

* *

*Principles of consolidation*

 

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries.  All materialintercompany balances and transactions are eliminated in consolidation.

* *

*Investment in available-for-salesecurities*

 

The Company has aportfolio of investments in certificates of deposit and commercial paper.  Management determines the appropriateclassification of the securities at the time they are acquired and evaluatesthe appropriateness of such classifications at each balance sheet date.  Management has determined that allsecurities should be classified as available for sale.  Available-for-sale securities are stated atfair value and unrealized holding gains and losses, net of the related deferredtax effect, are reported as a separate component of stockholders’ equity.  As of November 30, 2001 and 2002, theCompany had approximately $2.6 million and $500,000, respectively, incertificates of deposit and $2.6 million and none, respectively, in commercialpaper, with contractual maturity dates of up to one year.  Market values approximated carrying values.  Accordingly, no realized or unrealized gainsor losses were recorded during the three years ended November 30, 2002.

 

F-6

----

 

Premiums anddiscounts on investments in debt securities are amortized over the contractuallives of those securities.  The methodof amortization results in a constant effective yield on those securities (theinterest method).    Realized gains andlosses, including losses from declines in value of specific securitiesdetermined by management to be other than temporary, are included inincome.  Realized gains and losses aredetermined on the basis of the specific identification of the securitiessold.  The Company had no realized gainsor losses in fiscal years 2000, 2001 or 2002.

 

*Inventories*

 

Inventories arevalued at the lower of cost or market on a first-in, first-out basis.  The Company uses a standard cost system forpurposes of determining cost.  Thestandards are adjusted periodically to ensure they approximate actualcosts.  The Company writes down thecarrying value of inventory to market value for estimated obsolete or excessinventory based upon assumptions about future demand and marketconditions.  The Company comparescurrent inventory levels on a product basis to current sales forecasts in orderto assess the inventory balance Sales forecasts are based on economicconditions and trends (both current and projected), anticipated customerdemand, expected future products and other assumptions.  If actual market conditions are lessfavorable than those projected by management, additional write-downs may berequired.

 

*Equipment and leasehold improvements*

 

Equipment andleasehold improvements are recorded at cost. Equipment is depreciated using the straight-line method over theirestimated useful lives, currently five years. Improvements to leased property are amortized over the lesser of thelife of the lease or life of the improvements.

 

*Intangible assets*

 

Intangible assetsconsist of customer lists, core technology, assembled workforce and goodwill,which are being amortized on a straight-line basis over five to seven years.

 

*Evaluation of long-lived andintangible assets*

 

The Companyperiodically reviews the value of its long-lived and intangible assets todetermine if impairment has occurred by comparing the carrying value of thelong-lived and intangible assets with the future net undiscounted cash flowsexpected to result from the use of the assets, including cash flows fromdisposition.  Long-lived and intangibleassets evaluated for impairment are grouped with other assets to the lowestlevel for which identifiable cash flows are largely independent of the cashflows of other groups of assets and liabilities.  If the sum of the projected undiscounted cash flows (excludinginterest) is less than the carrying value of the assets, the assets will bewritten down to the estimated fair value in the period the determination ismade. Fair value is determined primarily based upon discounted cash flows. Asdiscussed in Note 14, the Company recorded an impairment loss on certainintangible assets during fiscal year 2001 based on an evaluation of projectedoperating income, cash flows and business prospects. In addition, managementdetermined other long-lived and intangible assets were not impaired. In makingthese determinations, the assumptions used by management about future cashflows are critical.  If these expectedcash flows are not realized, future additional impairment losses may berecorded.

 

F-7

----

 

*Revenue recognition*

 

Revenue from thesale of our equipment and supplies to end users, distributors, originalequipment manufacturers (OEM) and resellers is recognized when the product isshipped and the title is transferred to the buyer, net of an allowance forestimated returns, as long as no significant post-delivery obligations existand collection of the resulting receivable is probable.  Revenue from equipment maintenance andservice contracts is recorded as deferred income when billed and is recognizedstraight-line over the term of the contract. Warranty expense is estimated at the time revenue is recognized.  A warranty accrual for estimated futurewarranty obligations is recorded based upon the relationship between historicaland anticipated warranty costs and sales volumes.  To the extent increased warranty claim activity or increasedcosts associated with servicing those claims is experienced, the warrantyaccrual will increase resulting in decreased gross profit.

 

Revenue fromsoftware arrangements is recognized in accordance with Statement of Position(“SOP”) 97-2, “Software Revenue Recognition” as amended by SOP 98-9,“Modification of SOP 97-2 with Respect to Certain Transactions.” Revenue isrecognized when persuasive evidence of an arrangement exits and delivery hasoccurred, provided the fee is fixed or determinable, collectibility is probableand the arrangement does not require significant customization or modificationof the software.  For arrangements wherethe software requires significant customization or modification, the Companyrecognizes revenue for the software license and consulting services portion ofthe arrangement upon customer acceptance. Maintenance revenue is recognized ratably over the term of themaintenance contract, typically 12 months.

 

Revenue fromsoftware license agreements with OEMs whereby the Company provides ongoingsupport over the term of the contract is recognized based on the greater ofroyalties’ earned or straight line over the term of the contract.

 

*Trade receivables*

 

Trade receivablesare carried at original invoice amount less an estimate made for doubtfulreceivables resulting from the inability of customers to make requiredpayments.  The amount of the reserve isbased on historical experience and an analysis of the accounts receivableoutstanding.  If the financial conditionof the customers were to deteriorate, resulting in an impairment of theirability to make payments, additional allowances may be required which wouldresult in an additional expense in the period such determination was made.   Trade receivables are written off when deemed uncollectible.  Recoveries of trade receivables previouslywritten off are recorded when received. No interest is recorded on trade receivables.

 

*Research and development policy*

 

The Companyexpenses research and development costs, which are primarily salaries andbenefits, as they are incurred.  TheCompany incurs research and development costs in developing new products.

 

F-8

----

 

*Capitalized Software Development Costs*

 

Costs incurred forcomputer software development prior to establishing technological feasibilityare expensed as incurred.  Softwaredevelopment costs that the Company incurs following technological feasibility, and prior to the time theproduct is available for general release to customers are capitalized.Technological feasibility is determined at the earlier of completion of adetailed program design or a working model. Software development costscapitalized were $154,000, $1,314,000 and none during the years ended November30, 2000, 2001 and 2002 respectively. Capitalized software costs are amortized into cost of goods sold overthe greater of (1) the ratio of current gross revenue for the product to the currentand anticipated future gross revenues or (2) the straight-line method over theremaining economic life of the product, estimated to be five years.  Amortization expense related to capitalizedsoftware costs was $35,000, $46,000 and $433,000 in fiscal years 2000, 2001 and2002, respectively.  During fiscal year2002, the Company evaluated the net realizable value of the unamortizedcapitalized costs and recorded a charge to amortization expense of $707,000 towrite down the carrying value.

 

*Off-balance sheet financings andliabilities*

 

Other than leasecommitments and legal contingencies incurred in the normal course of business(see Notes 10 and 15), the Company does not have any off-balance sheetfinancing arrangements or liabilities. The Company does not have any majority-owned subsidiaries or anyinterests in, or relationships with, any material special-purpose entities thatare not included in the consolidated financial statements, except for a relatedparty lease arrangement.

 

*Advertising Costs*

 

Amounts incurredfor advertising costs with third parties are expensed as incurred.  Advertising expense totaled approximately$247,000, $152,000, and $193,000 for the years ended November 30, 2000, 2001and 2002, respectively.

 

*Reclassification*

 

Certainreclassifications have been made to the 2000 and 2001 financial statements toconform to the 2002 presentation with no effect on net income or stockholder’sequity.

 

*Income taxes*

 

Deferred taxes areprovided on a liability method whereby deferred tax assets are recognized fordeductible temporary differences and operating loss and tax creditcarryforwards and deferred tax liabilities are recognized for taxable temporarydifferences.  Temporary differences arethe differences between the reported amounts of assets and liabilities andtheir tax bases.  Deferred tax assetsare reduced by a valuation allowance when, in the opinion of management, it ismore likely than not that some portion or all of the deferred tax assets willnot be realized.  Deferred tax assetsand liabilities are adjusted for the effects of changes in tax laws and rateson the date of enactment.

 

F-9

----

 

*Stock-based compensation*

 

The Companyaccounts for stock-based employee compensation under the requirements ofAccounting Principles Board (APB) Opinion No. 25, which does not requirecompensation to be recorded if the consideration to be received is at leastequal to fair value of the shares to be received at the measurement date.  Nonemployee stock-based transactions areaccounted for under the requirements of Statement No. 123, *Accountingfor Stock-Based Compensation*, which requires compensation to berecorded based on the fair value of the securities issued or the servicesreceived, whichever is more reliably measurable.

 

*Fair value of financial instruments*

 

The Company’sfinancial instruments consist of cash and cash equivalents, available-for-salesecurities, accounts receivable, shareholder receivable, accounts payable andnotes payable.  The fair value of theshareholder receivable is not readily determinable due to the uncertaintiesregarding the split dollar life insurance arrangement. The carrying value ofthe other instruments is considered to be representative of their fair value,based on the short-term nature of these instruments and market rates ofinterest.

 

*Earnings per share*

 

Basic earnings pershare (EPS) is computed as net income (loss) divided by the weighted averagenumber of common shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur fromcommon shares issuable through exercise of stock options and warrants (537,000in the fiscal year ended November 30, 2000 and no shares in the fiscal yearsended November 30, 2001 and 2002, respectively).  The dilutive effect of options and warrants, which were notincluded in the total of diluted shares because the effect was antidilutive,was 74,000 shares and 51,000 in the fiscal years ended November 30, 2001 and2002, respectively.

 

*New accounting pronouncements*

 

In June 2001, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 142 (SFAS No. 142), *Goodwill and Other Intangible Assets*.    SFAS No. 142 addresses financialaccounting and reporting for acquired goodwill and other intangible assets andis effective for fiscal years beginning after December 15, 2001.  The Company will adopt SFAS No. 142 as ofDecember 1, 2003.  The Company is in theprocess of determining the expected impact on earnings and existing goodwilland other intangibles upon adoption which will include the elimination ofgoodwill amortization and may include additional impairment.  As of November 30, 2002, unamortizedgoodwill totaled $235,000.  Goodwillamortization was approximately $238,000, $294,000, and $73,000 in the yearsended November 30, 2000, 2001, and 2002, respectively.

 

The FASB recentlyissued SFAS No. 143, *Accounting for Asset Retirement Obligations*,addressing financial accounting and reporting for obligations associated withthe retirement of tangible long-lived assets and the associated assetretirement costs.  SFAS No. 143 requiresan enterprise to record the fair value of an asset retirement obligation as aliability in the period in which it incurs a legal obligation associated withthe retirement of a tangible long-lived asset. SFAS No. 143 also requires the enterprise to record the contra to theinitial obligation as an increase to the carrying amount of the relatedlong-lived asset and to depreciate that cost over the remaining useful life ofthe asset.  The liability is

 

F-10

----

 

changed at the end of each period to reflect the passage of time andchanges in the estimated future cash flows underlying the initial fair valuemeasurement. SFAS No. 143 is effective for the fiscal year beginning December1, 2003.  The Company is currentlyexamining the impact of this pronouncement on the results of its operations andfinancial position.

 

In August 2001,the FASB issued SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets,* which supersedes previous guidance on financialaccounting and reporting for the impairment or disposal of long-lived assetsand for segments of a business to be disposed of.  Adoption of SFAS 144 is required beginning December 1, 2003.  Management does not expect the adoption ofSFAS 144 to have a significant impact on the Company’s financial position orresults of operations.  However, furtherimpairment reviews may result in charges against earning to write down the valueof long-lived assets.

 

In June 2002, theFASB issued SFAS No. 146 *Accounting forCosts Associated with Exit or Disposal Activities.*  SFAS No. 146 generally requires companies torecognize costs associated with exit or disposal activities when they areincurred rather than at the date of a commitment to an exit or disposalplan.  This pronouncement is effectivefor exit or disposal activities intitated after December 31, 2002.  Statement 146 is not expected to have amaterial impact on the Company’s results of operations or financial position.

 

In December 2002,the FASB issued Interpretation No. 45, *Guarantor’sAccounting and Disclosure Requirments for Guarantees, Including IndirectGuarantees of Indebtedness of Others*.  Interpretation No. 45 requires that at the time a company issuesa guarantee, the company must recognize an initial liability for the fairvalue, or market value, of the obligations it assumes under thatguarantee.  This interpretation isapplicable on a prospective basis to guarantees issued or modified afterDecember 31, 2002.  The Interpretationis not expected to have a material impact on the company’s results ofoperations or financial position.

 

In January 2003, the Financial Accounting StandardsBoard issued FASB Interpretation No. 46 (FIN 46), *Consolidation of Variable Interest Entities, anInterpretation of Accounting Research Bulletin No. 51*” Prior toFIN 46, a company generally included another entity in the company’s financialstatements only if it controlled the entity through ownership of the majorityvoting interests.  FIN 46 requirescertain variable interest entities to be consolidated by the primarybeneficiary of the entity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties. FIN 46 is effective for allnew variable interest entities created or acquired after January 31, 2003.For variable interest entities created or acquired prior to February 1,2003, the provisions of FIN 46 must be applied for the quarter ending August31, 2003. We are currently analyzing the effect that the adoption of FIN 46will have on our results of operations and financial position, but expect thatupon the implementation date, it is reasonably possible that we will berequired to consolidate the related party leasing entity described Note 10 tothe consolidated financial statements.

The financial statements ofthe related party leasing entity for the year ended November 30, 2002 are currently not available;however, management estimates that if this entity is required to beconsolidated under the provisions of FIN 46, it would have no impact on revenuesand an insignificant impact on net income. The assets, primarily land and building, would be less than 5% of totalassets, the related liabilities, primarily notes payable to the bank, would beapproximately 10% of total liabilities and the net effect on stockholders'equity would not be material.

 

The Company paid a total of $270,000 to lease themanufacturing facility during each of the years ended November 30, 2002, 2001,and 2000 respectively.  The futureminimum lease commitments are included in Note 10.

 

When FIN 46 becomeseffective, the net amount that may be added to the Company’s balance sheet mayeither be reported as the cumulative effect of an accounting change, or byrestating previously issued financial statements with a cumulative-effectadjustment as of the beginning of the first year restated.  The Company has not yet determined themanner in which it will adopt FIN 46 in the event it is required to consolidatethe entity.

 

In December 2002,the Financial Accounting Standards Board issued FASB Statement No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure*.  Thisstatement amends FASB Statement No. 123, *Accountingfor Stock-Based Compensation*, to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. This statement does not require any change from the method currentlyused by the Company to account for stock-based compensation, but does requiremore prominent disclosure in the annual financial statement about the method ofaccounting for such compensation and the effect of the method used on reportedresults. This statement is effective for years ending after December 15,2002.  The Company has not yet adoptedthe disclosure provisions of SFAS No. 148 in the accompanying financialstatements.

 

F-11

----

 

**Note 2.  Business Combinations**

 

During the yearsended November 30, 2000 and 2001, the Company acquired the following companies,all of which were accounted for as purchase business combinations with theoperations included subsequent to their respective acquisition dates.

 

*American Development, Inc.*

 

On February 18, 2000, the Company acquired certain assets and assumedcertain liabilities of American Development, Inc., a software developmentcompany, in exchange for 42,654 shares of $0.01 par value common stock,$1,179,000 in cash and $54,000 in direct expenses.  The total acquisition cost was $2,652,000, including $330,000recorded in connection with warrants to purchase 15,000 shares of common stockissued to a consultant.

 

*CableNet Technologies*

 

On May 9, 2000, the Company acquired certain assets and assumed certainliabilities of North Carolina-based CableNet Technologies, which specializes inprinter enhancement and connectivity technology, in exchange for 54,386 sharesof $0.01 par value common stock, $1,945,000 in cash, $62,000 in directexpenses, including $306,000 recorded in connection with warrants to purchase28,334 shares of common stock issued to a consultant.  The total acquisition cost was $3,088,000.

 

*Extended Systems Incorporated*

 

On May 31, 2001, the Company acquired certain assets and assumedcertain liabilities of Extended Systems Incorporated, a print server manufacturer,in exchange for $1,672,000 in cash and $504,000 in direct expenses.  The total acquisition cost was $2,051,000.

 

*Unaudited pro forma information*

 

Unaudited proforma consolidated results of operations for the fiscal years ended November30, 2000 and 2001 as though these businesses had been acquired as of December1, 1999, is as follows:

 
|                                    |   | **2000**        |       | **2001**        |   |
|-----------------------------------------|--------|-----------------|------------|-----------------|--------|
|                                    |   | **(unaudited)** |       | **(unaudited)** |   |
| Sales                                   |   | $               | 69,582,000 |            | $      | 56,314,000 |   |
| Pro forma net  income (loss)            |   | 1,821,000       |       | (5,787,000      | )      |
| Pro forma net  income (loss) per share: |   |            |       |            |   |
| Basic                                   |   | 0.17            |       | (0.54           | )      |
| Diluted                                 |   | 0.16            |       | (0.54           | )      |
|                                         |        |                 |            |                 |        |  |  |

 

The above amountsreflect pro forma adjustments for amortization of intangibles, interest expenseand number of shares outstanding.  Thispro forma financial information does not purport to be indicative of theresults of operations had these acquisitions actually taken place at the earlier date.

 

F-12

----

 

**Note 3.  Inventories**

 

Inventoriesconsisted of the following as of November 30:

 
|                                              |   | **2001**   |      | **2002**   |   |
|---------------------------------------------------|--------|------------|-----------|------------|--------|
| Raw materials                                     |   | $          | 6,997,000 |       | $      | 5,136,000 |   |
| Work in process                                   |   | 455,000    |      | 205,000    |   |
| Finished goods                                    |   | 4,306,000  |      | 4,112,000  |   |
| Reserve for slow  moving and obsolete inventories |   | (2,507,000 | )         | (3,913,000 | )      |
|                                              |   | $          | 9,251,000 |       | $      | 5,540,000 |   |

 

**Note 4.  Equipment and Leasehold Improvements**

 

Equipment andleasehold improvements consisted of the following as of November 30:

 
|                                            |   | **2001**   |      | **2002**   |   |
|-------------------------------------------------|--------|------------|-----------|------------|--------|
| Machinery and  equipment                        |   | $          | 8,255,000 |       | $      | 8,491,000 |   |
| Furniture and  fixtures                         |   | 935,000    |      | 1,052,000  |   |
| Leasehold  improvements                         |   | 1,359,000  |      | 1,457,000  |   |
|                                            |   | 10,549,000 |      | 11,000,000 |   |
| Less accumulated  depreciation and amortization |   | 8,020,000  |      | 8,961,000  |   |
|                                            |   | $          | 2,529,000 |       | $      | 2,039,000 |   |

 

**Note 5.  Other Assets**

 

Other assetsconsisted of the following as of November 30:

 
|                                                                                           |   | **2001**  |      | **2002**  |   |
|------------------------------------------------------------------------------------------------|--------|-----------|-----------|-----------|--------|
|                                                                                           |   |      |      |      |   |
| Customer list,  net of accumulated amortization 2001 $13,000 and 2002 $16,000                  |   | $         | 12,000    |      | $      | 9,000 |   |
| Core technology,  net of accumulated amortization2001 $92,000 and 2002 $132,000                |   | 300,000   |      | 260,000   |   |
| Assembled  workforce, net of accumulatedamortization 2001 $65,000 and 2002 $79,000             |   | 60,000    |      | 46,000    |   |
| Goodwill, net of  accumulated amortization 2001$157,000 and 2002 $230,000                      |   | 308,000   |      | 235,000   |   |
| Cash surrender  value of officers’ life insurance                                         |   | 438,000   |      | 337,000   |   |
| Unsecured  receivable from stockholders                                                        |   | 1,666,000 |      | 2,123,000 |   |
| Software  development costs, net of accumulated amortization 2001 $93,000 and 2002  $1,233,000 |   | 1,790,000 |      | 650,000   |   |
| Long-term  deferred tax assets                                                                 |   | 580,000   |      | 676,000   |   |
| Other                                                                                          |   | 72,000    |      | 54,000    |   |
|                                                                                           |   | $         | 5,226,000 |      | $      | 4,390,000 |   |

 

**Note6.   Notes Payable**

 

The Company has a$5,000,000 line-of-credit agreement with a bank.  As of November 30, 2002, there were no borrowingsoutstanding against the line of credit. Borrowings under the line of credit bear interest at the lesser of thebank’s reference rate (4.25 % at November 29, 2002) less 0.25% or the bank’s

 

F-13

----

 

LIBOR rate (1.44 % at November 29, 2002) plus 2% and are limited to 80%of eligible accounts receivable and 50% of eligible inventories if total liabilities to tangible effective networth is greater than two to one.   Inconnection with the line-of-credit agreement, the Company has a $650,000standby letter-of-credit sublimit agreement of which approximately $80,000 wasoutstanding at November 30, 2002.  Theline of credit is secured by substantially all of the Company’s assets.  In connection with its borrowingarrangement, the Company is subject to certain financial covenants.  As of November 30, 2002, the Company had approximately$4,920,000 in availability under the line of credit.  The line-of-credit borrowings are due on demand.  The agreement may be terminated by eitherparty.

 

**Note 7.  Long-term Debt**

 

The Company has 4%to 5% economic, industrial and business development notes payable at November30, 2001 and 2002 totaling $263,000 and $193,000, respectively, which maturethrough 2005.  The notes are secured bycertain equipment.  One of the notes issecured by a fourth trust deed on real property owned by a company relatedthrough common ownership to the majority stockholders.  As of November 30, 2002, future maturitiesof long-term debt are as follows:  2003$73,000; 2004 $76,000 and 2005 $44,000.

 

**Note 8.  Accrued Expenses**

 

Accrued expensesconsisted of the following as of November 30:

 
|         |   | **2001**  |      | **2002** |   |
|--------------|--------|-----------|-----------|----------|--------|
| Compensation |   | $         | 1,373,000 |     | $      | 1,959,000 |   |
| Other        |   | 1,083,000 |      | 259,000  |   |
|         |   |      |      |     |   |
|         |   | $         | 2,456,000 |     | $      | 2,218,000 |   |

 

**Note 9.  Stockholders’ Equity**

 

*Preferred stock*

 

The Board ofDirectors has the authority, without action by the stockholders, to designateand issue any authorized but unissued shares of preferred stock in one or moreseries and to designate the rights, preferences and privileges of each suchseries.

 

*Stock option plans*

 

The Company hasreserved 2,700,000 shares of common stock for issuance under the Company’s 1998Stock Incentive Plan, of which 1,336,000 shares are subject to outstandingoptions as of November 30, 2002. Option prices for the incentive stock options will be 100% of the fairmarket value of the stock on the date the option is granted with an exerciseperiod of not more than ten years.  Forincentive options granted to 10% or more stockholders, the option price is 110%of the fair market value of the stock on the date the option is granted with anexercise period of not more than five years. Option prices for the nonqualified stock options shall not be less than85% of the fair market value of the stock on the date the options are grantedwith an exercise period of not more than ten years.  Vesting terms are determined by the Company at the date of grant.

 

F-14

----

 

*Stock Warrants*

 

The Company issuedwarrants to purchase 350,000 shares of common stock of the Company, of whichapproximately 132,000 are outstanding at November 30, 2002, to consultants andan attorney in connection with services provided relating to acquisitions, theCompany’s initial public offering and for other services.  No warrants were granted in 2001 or 2002.The warrants expire five years from the date granted.  The Company’s value of the grants were estimated at themeasurement date using the Black-Scholes option-pricing model with thefollowing assumptions:  no dividends;expected lives of one month to three years; expected amounts to be exercised of100%; risk free interest rates of 4.32% to 5.53%; and expected volatility of43% to 45%.

 

A summary of thestatus of the stock option plans and stock warrants and changes during fiscalyears 2000, 2001 and 2002 is as follows: 

 
|                                                         |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
|--------------------------------------------------------------|--------|-----------------------|--------|----------------------------------------|--------|
|                                                         |   |                  |   |                                   |   |
| Outstanding,  November 30, 1999                              |   | 1,305,000             |   | $                                      | 6.70   |   |
| Granted  (weighted average fair value $5.46)                 |   | 530,000               |   | 7.16                                   |   |
| Exercised                                                    |   | (114,334              | )      | (4.91                                  | )      |
| Forfeited                                                    |   | (42,000               | )      | (7.08                                  | )      |
| Outstanding,  November 30, 2000 (exercisable 548,666 shares) |   | 1,678,666             |   | 6.96                                   |   |
| Granted  (weighted average fair value $2.85)                 |   | 581,000               |   | 3.86                                   |   |
| Exercised                                                    |   | —                |   | —                                 |   |
| Forfeited                                                    |   | (274,000              | )      | (6.78                                  | )      |
| Outstanding,  November 30, 2001 (exercisable 753,877 shares) |   | 1,985,666             |   | 6.07                                   |   |
| Granted  (weighted average fair value $2.25)                 |   | 350,000               |   | 4.12                                   |   |
| Exercised                                                    |   | (10,000               | )      | 2.94                                   |   |
| Forfeited                                                    |   | (858,000              | )      | (5.79                                  | )      |
| Outstanding, November 30, 2002 (exercisable 717,618 shares)  |   | 1,467,666             |   | $                                      | 5.79   |   |

 

A further summaryof the options and warrants outstanding at November 30, 2002 is as follows: 

 
| **Options  and Warrants Outstanding** |   | **Options  and Warrants  Exercisable** |   |
|---------------------------------------|--------|----------------------------------------|--------|
| **Range of  Exercise Prices**         |   | **Number of  Options**                 |   | **Weighted  Average  Exercise  Price** |   | **Weighted  Average  Remaining  Life** |   | **Number of  Options** |   | **Weighted  Average  Exercise  Price** |   |
|                                  |   |                                   |   |   |   |   |   |   |   |   |   |
| $2.85 - $4.51                         |   | 708,666                                |   | $ | 3.92 |   | 6.9 |   | 219,040 |   | $ | 3.53 |   |
| 6.31 - 8.75                           |   | 734,000                                |   | 7.34 |   | 6.9 |   | 498,578 |   | 7.22 |   |
| 13.16 - 14.25                         |   | 25,000                                 |   | 13.38 |   | 7.0 |   | — |   | — |   |
| $2.85 - $14.25                        |   | 1,467,666                              |   | $ | 5.79 |   | 6.9 |   | 717,618 |   | $ | 6.09 |   |

 

F-15

----

 

There were1,364,000 remaining options available for grants under the plans at November30, 2002.

 

As permitted undergenerally accepted accounting principles, grants to employees under these plansare accounted for following APB Opinion No. 25 and relatedInterpretations.  Accordingly, nocompensation cost has been recognized for grants under the stock optionplan.  Had compensation cost beendetermined based on the grant date fair value of awards, and employee stockpurchases as prescribed in FASB Statement No. 123, reported net income, afterthe pro forma provision for income taxes, and earnings per common share, wouldhave been reduced to the amounts shown below:

 
|                                |   | **2000**  |      | **2001** |       | **2002**   |   |
|-------------------------------------|--------|-----------|-----------|----------|------------|------------|--------|
| Net income  (loss):                 |   |      |      |     |       |       |   |
| As reported                         |   | $         | 2,407,000 |     | $          | (5,945,000 | )      | $ | (3,175,000 | ) |
| Pro forma                           |   | 1,176,000 |      | $        | (7,279,000 | )          | $      | (3,688,000 | ) |
|                                |   |      |      |     |       |       |   |
| Basic earnings  per share (loss):   |   |      |      |     |       |       |   |
| As reported                         |   | 0.22      |      | (0.55    | )          | (0.30      | )      |
| Pro forma                           |   | 0.11      |      | (0.68    | )          | (0.35      | )      |
|                                |   |      |      |     |       |       |   |
| Diluted earnings  per share (loss): |   |      |      |     |       |       |   |
| As reported                         |   | 0.21      |      | (0.55    | )          | (0.30      | )      |
| Pro forma                           |   | 0.10      |      | (0.68    | )          | (0.35      | )      |
|                                     |        |           |           |          |            |            |        |  |  |  |

 

In determining thepro forma amounts above, the value of each grant is estimated at the grant dateusing the Black-Scholes option-pricing method with the following assumptionsfor grants in 2000, 2001 and 2002:  nodividends; risk-free interest rates of 5.85% to 6.73%; 3.61% to 4.96%; and1.41% to 2.51%, respectively; expected lives of ten years in 2000 and and fiveand ten years in 2001 and 2002; expected amounts to be exercised of 100%; andprice volatility of 45% to 69%.

 

*Employee stock purchase plan*

 

The Company has astock purchase plan covering substantially all employees and has reserved200,000 shares for issuance under this plan. Shares are purchased subsequent to the end of the annual offering periodfor 85% of the lower of the fair market value on the first day or last day ofthe Plan year offering period.  Duringthe years ended November 30, 2000,  2001and 2002, 14,654 , 40,268 and 38,625 shares were purchased for $76,000 $158,000and $119,000, respectively, under the plan. At November 30, 2002, $34,000 was accrued for employee stock purchaseswhich represents approximately 22,000 shares at $1.56 per share.

 

*Retained earnings*

 

The Company islimited in its ability to declare and pay dividends by the terms of certaindebt agreements.

 

*Stock Repurchase Program*

 

The companyestablished a stock repurchase program under which common stock, with anaggregate market value up to $4.0 million, may be acquired in the openmarket.  As of November 30, 2002,

 

F-16

----

 

the Company has purchased 320,565 shares of common stock in the openmarket at an average price of $3.67 per share (total $1,175,000) under thisprogram.

 

**Note 10.  Related-party Transactions, Lease Commitments and Rent Expense**

 

The Company leasesits operating facilities under non-cancelable operating lease agreements,including certain operating facilities from a company related through commonownership,  which expire through2008.  The related-party lease requiresmonthly payments of approximately $22,500.

 

Rent expense infiscal years 2000, 2001 and 2002 was approximately $637,000, $790,000 and$847,000, respectively.  Future minimumrental commitments under these leases in the fiscal years ending November 30are as follows:  2003 $663,000; 2004$437,000; 2005 $340,000; 2006 $270,000; 2007 $270,000; 2008 $90,000 (total$2,070,000, including $1,438,000 to a related party).

 

As of November 30,2002, the Company has advanced $2,123,000, respectively, to stockholders inconnection with the purchase of split dollar life insurance policies.  The Company and the stockholders haveexecuted a split-dollar agreement governing the unsecured, non-interest-bearingreceivable for the amount of the advances. The advances are due on demand, however the Company does not anticipatedemanding payment and accordingly has classified this amount as long-term.

 

F-17

----

 

**Note 11.  Income Tax Matters**

 

Net deferred taxassets consist of the following components as of November 30:

 
|                                                              |   | **2001**  |      | **2002**  |   |
|-------------------------------------------------------------------|--------|-----------|-----------|-----------|--------|
| Deferred tax  liabilities:                                        |   |      |      |      |   |
| Equipment and  leasehold improvements                             |   | $         | (21,000   | )         | $      | (53,000 | ) |
|                                                              |   |      |      |      |   |
| Deferred tax  assets:                                             |   |      |      |      |   |
| Inventories  valuation                                            |   | 981,000   |      | 1,472,000 |   |
| Accounts  receivable allowance and valuation                      |   | 425,000   |      | 331,000   |   |
| Accrued  compensation                                             |   | 154,000   |      | 186,000   |   |
| Accrued warranty  and other                                       |   | 273,000   |      | 400,000   |   |
| Deferred revenue                                                  |   | 349,000   |      | 318,000   |   |
| Customer list,  core technology, assembled workforce and goodwill |   | 601,000   |      | 729,000   |   |
| Tax credit  carryforwards                                         |   | 298,000   |      | 1,008,000 |   |
|                                                              |   | 3,081,000 |      | 4,444,000 |   |
|                                                              |   |      |      |      |   |
| Net deferred tax  assets                                          |   | $         | 3,060,000 |      | $      | 4,391,000 |   |

 

The Company hasnot established a valuation allowance for the deferred tax assets, becausemanagement believes the deferred tax assets are more likely than not to berealized based on current expectations of future earnings and available taxplanning strategies.

 

The net deferredtax assets have been classified on the accompanying consolidated balance sheetsas of November 30 as follows:

 
|             |   | **2001** |      | **2002** |   |
|------------------|--------|----------|-----------|----------|--------|
|             |   |     |      |     |   |
| Current assets   |   | $        | 2,480,000 |     | $      | 3,715,000 |   |
| Long-term assets |   | 580,000  |      | 676,000  |   |
|             |   |     |      |     |   |
|             |   | $        | 3,060,000 |     | $      | 4,391,000 |   |

 

The Company hastax credit carryforwards of $1,008,000. Of this amount, $475,000 are availableto offset U.S. Federal income tax and expire in 2022.  The remaining credit carryforwards of $533,000 are available to offsetcertain state income taxes and expire as follows: $53,000 in 2005 and $480,000with an indefinite life.

 

The provision(benefit) for income taxes charged to operations for the years ended November30, 2000, 2001 and 2002 are as follows.

 
|         |   | **2000**  |      | **2001**   |   | **2002**   |   |
|--------------|--------|-----------|-----------|------------|--------|------------|--------|
| Current:     |   |      |      |       |   |       |   |
| U.S. federal |   | $         | 1,013,000 |       | $      | (1,961,000 | )      | $ | (643,000 | ) |
| State        |   | 204,000   |      | 56,000     |   | 37,000     |   |
| Foreign      |   | 218,000   |      | 320,000    |   | 255,000    |   |
|         |   | 1,435,000 |      | (1,585,000 | )      | (351,000   | )      |
| Deferred:    |   |      |      |       |   |       |   |
| U.S. federal |   | (217,000  | )         | (2,065,000 | )      | (1,002,000 | )      |
| State        |   | (81,000   | )         | (133,000   | )      | (331,000   | )      |
| Foreign      |   | 15,000    |      | (20,000    | )      | 2,000      |   |
|         |   | (283,000  | )         | (2,218,000 | )      | (1,331,000 | )      |
|         |   |      |      |       |   |       |   |
|         |   | $         | 1,152,000 |       | $      | (3,803,000 | )      | $ | (1,682,000 | ) |

 

F-18

----

 

The historicalincome tax provision for fiscal years 2000, 2001 and 2002 differs from theamount of income tax determined by applying the U.S. federal income tax rate topretax income due to the following: 

 
|                                              |   | **2000** |   | **2001** |   | **2002** |   |
|---------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                              |   |     |   |     |   |     |   |
| Computed  “expected” tax rate (benefit) |   | 35       | %      | (35      | )%     | (35      | )%     |
| Increase  (decrease)                              |   |     |   |     |   |     |   |
| State income  taxes, net of federal benefit       |   | 5        |   | —   |   | —   |   |
| Research and  development and other tax credits   |   | (12      | )      | (11      | )      | (5       | )      |
| Goodwill  amortization and impairment             |   | —   |   | 4        |   | —   |   |
| Other                                             |   | 4        |   | 3        |   | 5        |   |
|                                              |   |     |   |     |   |     |   |
|                                              |   | 32       | %      | (39      | )%     | (35      | )%     |

 

Pretax income(loss) subject to foreign and U.S. income taxes for fiscal year 2000 was:$475,000 and $2,129,000, respectively, for fiscal year 2001, was: $451,000 and$(2,191,000), respectively, and for fiscal year 2002, was: $624,000 and $(3,241,000),respectively.

 

**Note 12.  Major Vendors**

 

The Company purchases key components from a vendor and also sellsproducts to this same vendor.  Purchasesfrom this vendor for fiscal years 2000, 2001 and 2002 were: $10,047,000,$5,906,000, and $8,798,000, repectively. Net payable balances as of November 30, 2000, 2001 and 2002 were:$308,000, $397,000, and $396,000.

 

**Note 13.  Segment Information and Geographical Information**

 

*Segment information*

 

The Company’sreportable segments are strategic business units.  They are managed separately because each business unit requiresdifferent technology and marketing strategies.

 

There are tworeportable segments:  Security PrintingSolutions (previously TROY Systems) and Wireless and Connectivity Solutions (previouslyTROY Wireless).  Security PrintingSolutions includes software, firmware, hardware and imaging supplies thatprovide state-of-the-art payment systems ranging from high security digitalcheck printing systems to electronic payment and funds transfer solutions.  Wireless and Connectivity Solutions productsinclude software, firmware and hardware that enable enterprises to shareintelligent devices like printers either wirelessly or using traditionalnetworks.

 

The accountingpolicies applied to determine the segment information are the same as thosedescribed in the summary of significant accounting policies.  Intersegment sales and transfers areaccounted for at amounts that assume the sales or transfers were to unrelatedthird parties at the current market prices at the time of thetransactions.  Management evaluates theperformance of each segment based on income or loss from operations beforeincome taxes.

 

F-19

----

 

Financialinformation with respect to the reportable segments follows:

 
|                                            |   | **Security  Printing  Solutions** |   | **Wireless  and  Connectivity  Solutions** |   | **Unallocated  Corporate** |   | **Total**  |   |
|-------------------------------------------------|--------|-----------------------------------|--------|--------------------------------------------|--------|----------------------------|--------|------------|--------|
| ***Fiscal year 2000***                          |   |                              |   |                                       |   |                       |   |       |   |
| Revenue:                                        |   |                              |   |                                       |   |                       |   |       |   |
| Software,  firmware and hardware                |   | 3,136,000                         |   | 9,362,000                                  |   | —                     |   | 12,498,000 |   |
| Printers and  services                          |   | 13,654,000                        |   | —                                     |   | —                     |   | 13,654,000 |   |
| Imaging supplies                                |   | 27,078,000                        |   | —                                     |   | —                     |   | 27,078,000 |   |
| Total revenue                                   |   | 43,868,000                        |   | 9,362,000                                  |   | —                     |   | 53,230,000 |   |
| Intersegment  revenue                           |   | 712,000                           |   | 208,000                                    |   | —                     |   | 920,000    |   |
| Depreciation and  amortization expense          |   | 518,000                           |   | 331,000                                    |   | 831,000                    |   | 1,680,000  |   |
| Interest income                                 |   | 1,000                             |   | —                                     |   | 864,000                    |   | 865,000    |   |
| Interest expense                                |   | 17,000                            |   | —                                     |   | 2,000                      |   | 19,000     |   |
| Segment profit                                  |   | 6,429,000                         |   | 759,000                                    |   | (3,629,000                 | )      | 3,559,000  |   |
| Income taxes  (credit)                          |   | 2,597,000                         |   | 307,000                                    |   | (1,752,000                 | )      | 1,152,000  |   |
| Net income                                      |   | 3,832,000                         |   | 452,000                                    |   | (1,877,000                 | )      | 2,407,000  |   |
| Goodwill                                        |   | 740,000                           |   | 783,000                                    |   | —                     |   | 1,523,000  |   |
| Segment assets                                  |   | 16,353,000                        |   | 6,355,000                                  |   | 24,766,000                 |   | 47,474,000 |   |
| Expenditures for  segment assets                |   | 529,000                           |   | 230,000                                    |   | —                     |   | 759,000    |   |
|                                            |   |                              |   |                                       |   |                       |   |       |   |
| ***Fiscal year 2001***                          |   |                              |   |                                       |   |                       |   |       |   |
| Revenue:                                        |   |                              |   |                                       |   |                       |   |       |   |
| Software,  firmware and hardware                |   | 3,670,000                         |   | 11,136,000                                 |   | —                     |   | 14,806,000 |   |
| Printers and  services                          |   | 10,386,000                        |   | —                                     |   | —                     |   | 10,386,000 |   |
| Imaging supplies                                |   | 24,310,000                        |   | —                                     |   | —                     |   | 24,310,000 |   |
| Total revenue                                   |   | 38,366,000                        |   | 11,136,000                                 |   | —                     |   | 49,502,000 |   |
| Intersegment  revenue                           |   | 230,000                           |   | 54,000                                     |   |                       |   | 284,000    |   |
| Depreciation and  amortization expense          |   | 588,000                           |   | 606,000                                    |   | 865,000                    |   | 2,059,000  |   |
| Impairment of  long-lived and intangible assets |   | (1,945,000                        | )      | (3,689,000                                 | )      | —                     |   | (5,634,000 | )      |
| Interest income                                 |   | —                            |   | —                                     |   | 515,000                    |   | 515,000    |   |
| Interest expense                                |   | (80,000                           | )      | —                                     |   | (58,000                    | )      | (138,000   | )      |
| Segment profit  (loss)                          |   | 4,760,000                         |   | (6,747,000                                 | )      | (7,761,000                 | )      | (9,748,000 | )      |
| Income taxes  (credit)                          |   | 1,719,000                         |   | (2,380,000                                 | )      | (3,142,000                 | )      | (3,803,000 | )      |
| Net income  (loss)                              |   | 3,041,000                         |   | (4,367,000                                 | )      | (4,619,000                 | )      | (5,945,000 | )      |
| Goodwill                                        |   | 308,000                           |   | —                                     |   | —                     |   | 308,000    |   |
| Segment assets                                  |   | 13,395,000                        |   | 10,259,000                                 |   | 28,663,000                 |   | 52,317,000 |   |
| Expenditures for  segment assets                |   | 420,000                           |   | 770,000                                    |   | 31,000                     |   | 1,221,000  |   |
|                                            |   |                              |   |                                       |   |                       |   |       |   |
| ***Fiscal year 2002***                          |   |                              |   |                                       |   |                       |   |       |   |
| Revenue:                                        |   |                              |   |                                       |   |                       |   |       |   |
| Software,  firmware and hardware                |   | 3,044,000                         |   | 13,224,000                                 |   | —                     |   | 16,268,000 |   |
| Printers and  services                          |   | 11,709,000                        |   | —                                     |   | —                     |   | 11,709,000 |   |
| Imaging supplies                                |   | 27,326,000                        |   | —                                     |   | —                     |   | 27,326,000 |   |
| Total revenue                                   |   | 42,079,000                        |   | 13,224,000                                 |   | —                     |   | 55,303,000 |   |
| Intersegment  revenue                           |   | 305,000                           |   | —                                     |   | —                     |   | 305,000    |   |
| Depreciation and  amortization expense          |   | 973,000                           |   | 1,144,000                                  |   | 17,000                     |   | 2,134,000  |   |
| Interest income                                 |   | —                            |   | —                                     |   | 101,000                    |   | 101,000    |   |
| Interest expense                                |   | (34,000                           | )      | —                                     |   | —                     |   | (34,000    | )      |
| Segment profit  (loss)                          |   | 5,812,000                         |   | (5,575,000                                 | )      | (5,094,000                 | )      | (4,857,000 | )      |
| Income taxes  (credit)                          |   | 2,314,000                         |   | (1,550,000                                 | )      | (2,446,000                 | )      | (1,682,000 | )      |
| Net income  (loss)                              |   | 3,498,000                         |   | (4,025,000                                 | )      | (2,648,000                 | )      | (3,175,000 | )      |
| Goodwill                                        |   | 235,000                           |   | —                                     |   | —                     |   | 235,000    |   |
| Segment assets                                  |   | 11,637,000                        |   | 10,339,000                                 |   | 24,478,000                 |   | 46,454,000 |   |
| Expenditures for  segment assets                |   | 308,000                           |   | 40,000                                     |   | 26,000                     |   | 374,000    |   |

 

F-20

----

 

The followingschedule is presented to reconcile fiscal years 2000, 2001 and 2002 amounts inthe foregoing segment information to the amounts reported in the Company’sconsolidated financial statements. 

 
|                                  |   | **2000**   |       | **2001**    |   | **2002**    |   |
|---------------------------------------|--------|------------|------------|-------------|--------|-------------|--------|
| Assets                                |   |       |       |        |   |        |   |
| Total assets of  reportable segments  |   | $          | 47,474,000 |        | $      | 52,317,000  |   | $ | 46,454,000 |   |
| Intersegment  receivables             |   | (4,797,000 | )          | (14,928,000 | )      | (12,681,000 | )      |
| Investment in  subsidiaries           |   | (957,000   | )          | (382,000    | )      | (234,000    | )      |
|                                  |   |       |       |        |   |        |   |
| Consolidated  assets                  |   | $          | 41,720,000 |        | $      | 37,007,000  |   | $ | 33,539,000 |   |
|                                  |   |       |       |        |   |        |   |
| Revenue                               |   |       |       |        |   |        |   |
| Total revenue of  reportable segments |   | $          | 53,230,000 |        | $      | 49,502,000  |   | $ | 55,303,000 |   |
| Intersegment  revenue                 |   | (920,000   | )          | (284,000    | )      | (305,000    | )      |
| Consolidated  revenue                 |   | $          | 52,310,000 |        | $      | 49,218,000  |   | $ | 54,998,000 |   |

 

*Geographic information*

 

The Companyoperates in both U.S. and foreign markets. Geographic sales information is based on the ordering location of thecustomer.  Equipment and leaseholdimprovements information is based on the physical location of the assets.  The following is net sales and equipment andleasehold improvements by geographic region:

 
|                                       |   | **United  States** |       | **All other  Countries** |   | **Total** |   |
|--------------------------------------------|--------|--------------------|------------|--------------------------|--------|-----------|--------|
| ***Fiscal year 2000***                     |   |               |       |                     |   |      |   |
| Net sales                                  |   | $                  | 45,154,000 |                     | $      | 7,156,000 |   | $ | 52,310,000 |   |
| Equipment and  leasehold improvements, net |   | 1,859,000          |       | 181,000                  |   | 2,040,000 |   |
|                                       |   |               |       |                     |   |      |   |
| ***Fiscal year 2001***                     |   |               |       |                     |   |      |   |
| Net sales                                  |   | $                  | 41,876,000 |                     | $      | 7,342,000 |   | $ | 49,218,000 |   |
| Equipment and  leasehold improvements, net |   | 2,349,000          |       | 180,000                  |   | 2,529,000 |   |
|                                       |   |               |       |                     |   |      |   |
| ***Fiscal year 2002***                     |   |               |       |                     |   |      |   |
| Net sales                                  |   | $                  | 45,632,000 |                     | $      | 9,366,000 |   | $ | 54,998,000 |   |
| Equipment and  leasehold improvements, net |   | 1,891,000          |       | 148,000                  |   | 2,039,000 |   |

 

**Note 14.  Impairment of Long-Lived Assets**

 

During the fourthquarter of fiscal year 2001, the Company initiated an analysis of itslong-lived assets in accordance with Statement of Financial AccountingStandards No. 121, “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to be Disposed Of” (“SFAS 121”), to determine if there wasimpairment of its long-lived assets. This analysis was initiated due to changes in the Company’s businessenvironment, which were highlighted during the Company’s annual businessplanning process, and certain changes in Company’s management.  This analysis was done on a business unit byunit basis as it was determined that these units were independent of each otherand were the

 

F-21

----

 

lowest level for which cash flows could be identified.  The business units identified were similarto the businesses acquired by the Company since 1998.  The analysis demonstrated that the acquired print server productsand technologies were at or approaching their end-of life and that the ACHprocessing services  were not generatingthe cash flows anticipated when this business unit was acquired.  The Company completed this analysis with theassistance of an independent valuation firm. The analysis indicated that these business units would not generatesufficient positive cash flows over the projected period of five years, whichapproximated the remaining life of the long-lived assets, and that there was nocurrent value or residual value beyond the value of the net current assets andcertain property and equipment. Substantially all of the intangible assets of certain of these businessunits were written off at November 30, 2001 because they are projected togenerate insufficient positive cash flows. Certain property and equipment of these business units were not writtenoff because they continue to be used in operations and were determined to havevalue.  As a result of this analysis,the Company recorded a charge in 2001 of $5,634,000 for the impairment oflong-lived assets on a business unit by unit basis as follows:

 
| **Business Unit**     |   | **Amount** |      | **Segment**                  |                       |
|-----------------------|--------|------------|-----------|------------------------------|----------------------------|
|                  |   |       |      |                         |                       |
| XCD                   |   | $          | 1,085,000 |                         | Wireless and  Connectivity |   |
| American  Development |   | 1,945,000  |      | Security  Printing Solutions |                       |
| CableNet              |   | 2,074,000  |      | Wireless and  Connectivity   |                       |
| ESI                   |   | 530,000    |      | Wireless and  Connectivity   |                       |
| Total                 |   | $          | 5,634,000 |                         |                       |   |

 

The amortizationexpense recorded for these assets in 2001 prior to the recorded impairmentcharge was $1,261,000.

 

**15. Contingencies**

 

On November 21,2002, Tom Lloyd filed an action in the Superior Court of the State of Californiain and for Orange County against the Company and its directors, alleging thatdefendants breached their fiduciary duties by attempting to provide the Dirkfamily with preferential treatment in connection with their efforts to completea sale of the company. The complaint seeks to enjoin an acquisition of theCompany by the Dirk family, as well as attorneys’ fees. The Company believesthat it and the individual defendants have meritorious defenses in the Lloydaction, and intends to continue to defend this lawsuit vigorously. If thislitigation is resolved in favor of the plaintiffs, however, it could have amaterial adverse effect on the Company and its stockholders.

 

**16. Fourth Quarter, 2002 Adjustments**

 

In thefourth quarter of fiscal year 2002, the Company performed an extensive analysisof the Wireless & Connectivity segment due to changes in the economic,technical and competitive conditions that occurred during this period.  As a result of this analysis, the Companyrecorded a charge for excess and obsolete inventories of $1,878,000 andrecorded an amortization charge of $707,000 to write down capitalized softwaredevelopment costs to net realizable value during the fourth quarter.  

 

F-22

----

 

**Note 17.  Cash Flow and Other Information**

** **
|                                                                                                                              |   | **2000**  |      | **2001**  |   | **2002**   |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-----------|-----------|-----------|--------|------------|--------|
|                                                                                                                              |   |      |      |      |   |       |   |
| Cash paid for:                                                                                                                    |   |      |      |      |   |       |   |
| Interest                                                                                                                          |   | $         | 20,000    |      | $      | 139,000    |   | $ | 51,000 |   |
|                                                                                                                              |   |      |      |      |   |       |   |
| Income taxes                                                                                                                      |   | $         | 2,433,000 |      | $      | 418,000    |   | $ | 299,000 |   |
|                                                                                                                              |   |      |      |      |   |       |   |
| Supplemental  schedule of noncash operating, investing and financing activities:                                                  |   |      |      |      |   |       |   |
| Purchase of  American Development, Inc. and Cablenet  Technologies in 2000 and Extended   Systems Incorporated in 2001: |   |      |      |      |   |       |   |
| Working capital                                                                                                                   |   | $         | 48,000    |      | $      | 1,475,000  |   | $ | — |   |
| Equipement and  leasehold improvements                                                                                            |   | 78,000    |      | 46,000    |   | —     |   |
| Other assets                                                                                                                      |   | 94,000    |      | —    |   | —     |   |
| Intangible  assets                                                                                                                |   | 5,520,000 |      | 530,000   |   | —     |   |
| Total purchase  price                                                                                                             |   | $         | 5,740,000 |      | $      | 2,051,000  |   | — |   |
| Less fair value of common stock and stock warrants issued in  connection with the acquisition                                     |   | 2,500,000 |      | —    |   | —     |   |
|                                                                                                                              |   |      |      |      |   |       |   |
| Cash purchase price                                                                                                               |   | $         | 3,240,000 |      | $      | 2,051,000  |   | $ | — |   |
|                                                                                                                              |   |      |      |      |   |       |   |
| Accounts  receivable charged off                                                                                                  |   | $         | 146,000   |      | $      | 507,000    |   | $ | 234,000 |   |
|                                                                                                                              |   |      |      |      |   |       |   |
| Fair value of  stock warrants issued for services                                                                                 |   | $         | 120,000   |      | $      | —     |   | $ | — |   |
|                                                                                                                              |   |      |      |      |   |       |   |
| Reserve for slow  moving and obsolete inventories:                                                                                |   |      |      |      |   |       |   |
| Balance,  beginning of year                                                                                                       |   | $         | 1,458,000 |      | $      | 881,000    |   | $ | 2,507,000 |   |
| Provision  charged off to expense                                                                                                 |   | 240,000   |      | 2,371,000 |   | 2,619,000  |   |
| Charge offs to  reserve                                                                                                           |   | (817,000  | )         | (745,000  | )      | (1,213,000 | )      |
| Balance, end of  year                                                                                                             |   | $         | 881,000   |      | $      | 2,507,000  |   | $ | 3,913,000 |   |

 

F-23

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this Report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Dated:  March  17, 2003 | TROY GROUP, INC. |
|-----------------------------------|------------------|
|                              |             |   |   |
|                              |             |   |   |
|                              |             | By | /s/ Patrick J.  Dirk |   |
|                              |             |   | Patrick J. Dirk |
|                              |             |   | Chief Executive  Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned below on March 17, 2003 by the following persons on behalf of theRegistrant and in the capacities indicated.

 
| **Signature**                            |   | **Title**                                            |
|------------------------------------------|--------|------------------------------------------------------|
|                                     |   |                                                 |
|    /s/  Patrick J. Dirk   |   | Chairman and  Chief Executive Officer                |
| Patrick J. Dirk                          |   | (Principal  Executive Officer)                       |
|                                     |   |                                                 |
|    /s/  Brian Dirk        |   | Vice Chairman,  Senior Vice President, and Secretary |
| Brian P. Dirk                            |   |                                                 |
|                                     |   |                                                 |
|    /s/  James W. Klingler |   | Vice  President-Finance, Treasurer and Chief         |
| James W.  Klingler                       |   | Financial  Officer (Principal Financial and          |
|                                     |   | Accounting  Officer)                                 |
|                                     |   |                                                 |
|    /s/  Norman B. Keider  |   | Director                                             |
| Norman B. Keider                         |   |                                                 |
|                                     |   |                                                 |
|    /s/  Harold L. Clark   |   | Director                                             |
| Dr. Harold L.  Clark                     |   |                                                 |
|                                     |   |                                                 |
|    /s/  John B. Zaepfel   |   | Director                                             |
| John B. Zaepfel                          |   |                                                 |

 

* * * * *

 

*The written statements requiredpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, have been filed as exhibits to this report.*

 

----

 

**CERTIFICATIONS**

 

I, Patrick J.Dirk, certify that:

 

1.                                       Ihave reviewed this annual report on Form 10-K of Troy Group, Inc.;

 

2.                                       Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report; and

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report.

 

4.                                       The registrant’s other certifying officer and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

(a)                                  designed such disclosure controls and proceduresto ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

(b)                                 evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

(c)                                  presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officer and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

(a)                                  all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

(b)                                 any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.                                       The registrant’s other certifying officer and Ihave indicated in this annual report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Date:  March  17, 2003 | /s/Patrick J.  Dirk                    |   |
|----------------------------------|----------------------------------------|--------|
|                             | Patrick J. Dirk                        |
|                             | President and  Chief Executive Officer |

 

----

 

**CERTIFICATIONS**

 

I, James W.Klingler certify that:

 

1.                                       Ihave reviewed this annual report on Form 10-K of Troy Group, Inc.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this annual report;and

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report.

 

4.                                       The registrant’s other certifying officer and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

(a)                                  designed such disclosure controls and proceduresto ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

(b)                                 evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

(c)                                  presented in this annual report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officer and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

(a)                                  all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internal controls;and

 

(b)                                 any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.                                       The registrant’s other certifying officer and Ihave indicated in this annual report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Date:  March  17, 2003 | /s/James W.  Klingler                  |   |
|----------------------------------|----------------------------------------|--------|
|                             | James W.  Klingler                     |
|                             | Vice  President-Finance, Treasurer and |
|                             | Chief Financial  Officer               |

 

----

 

**TROY GROUP, INC.**

** **

Exhibit Index to Annual Report

on Form 10-K

 

For the fiscal year endedNovember 30, 2002

 
| **Item  No.** |   | **Description**                                                                                                                               |   | **Method of  Filing**                                                                                                                       |
|---------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 2.1           |   | Merger Purchase Agreement dated October 28, 1998  between TROY Group, TROY Merger Subsidiary, Inc. and XCD Incorporated and its  stockholders |   | Incorporated by reference to Exhibit 2.1 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).               |
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 3.1           |   | Certificate of Incorporation of TROY Group                                                                                                    |   | Incorporated by reference to Exhibit 3.1 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).          |
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 3.2           |   | Bylaws of TROY Group                                                                                                                          |   | Incorporated by reference to Exhibit 3.2 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).          |
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 10.1          |   | Lease dated March 16, 1995 between TROY Systems  International, Inc. and Ragco, as amended on May 18, 1998                               |   | Incorporated by reference to Exhibit 10.1 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).         |
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 10.2          |   | Amendment to the Lease dated August 24, 2000 between  TROY Systems International, Inc. and Ragco, a general partnership                       |   | Incorporated by reference to Exhibit 10.1 to TROY  Group’s Form 10-Q for the quarter ended August 31, 2000 (File No.  000-24413). |
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 10.3          |   | Lease dated July 28, 1993 between Dirk Investments,  Inc. and TROY Group                                                                      |   | Incorporated by reference to Exhibit 10.2 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).         |
|          |   |                                                                                                                                          |   |                                                                                                                                        |
| 10.4          |   | Lease Amendment to Lease dated July 28, 1993 between  Dirk Investments, Inc. and TROY Group                                                   |   | Incorporated by reference to Exhibit 10.3 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).         |

 

E-1

----

 
| **Item  No.** |   | **Description**                                                                                                                                                                                                             |   | **Method of  Filing**                                                                                                                                                |
|---------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.5          |   | Addendum to Lease dated March 16, 1995 between Dirk  Investments, Inc. and TROY Group                                                                                                                                       |   | Incorporated by reference to Exhibit 10.4 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                  |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.6          |   | Lease Amendment to Lease dated September 1,  1996 between Dirk Investments, Inc. and TROY Group                                                                                                                        |   | Incorporated by reference to Exhibit 10.5 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                  |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.7          |   | Lease dated March 1, 1998 between Sanwa Bank  California and XCD, Inc. and a Consent to Assignment of Lease, Assignment and  Acceptance dated October 23, 1998 between Sanwa Bank California, XCD, Inc.  and TROY XCD, Inc. |   | Incorporated by reference to Exhibit 10.6 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                  |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.8          |   | 1996 Stock Option Plan                                                                                                                                                                                                      |   | Incorporated by reference to Exhibit 10.7 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                  |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.9          |   | 1998 Stock Incentive Plan, as amended                                                                                                                                                                                       |   | Incorporated by reference to Exhibit 10.2 to TROY  Group’s Form 10-Q for the quarter ended August 31, 2000 (File No. 000-24413).                                |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.10         |   | 1998 Employee Stock Purchase Plan                                                                                                                                                                                           |   | Incorporated by reference to Exhibit 10.9 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                  |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.11         |   | Non-Competition Agreement dated November 27, 1996  between Robert Messina and TROY Group                                                                                                                                    |   | Incorporated by reference to Exhibit 10.12 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.12         |   | Restated Consulting Agreement dated October 1, 1997  between TROY Group and Broadland Capital Partners, as amended through  November 1, 1999                                                                                |   | Incorporated by reference to Exhibit 10.11 to TROY  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  1999 (File No.  000-24413). |
|          |   |                                                                                                                                                                                                                        |   |                                                                                                                                                                 |
| 10.13         |   | Form of Indemnification Agreement for directors and  executive officers of TROY Group                                                                                                                                       |   | Incorporated by reference to Exhibit 10.14 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |

 

E-2

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| **Item  No.** |   | **Description**                                                                                                                                  |   | **Method of  Filing**                                                                                                                                                |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.14         |   | MICR Supplies Agreement dated February 6, 1998  between TROY Group and IBM Printing Systems Company(1)                                           |   | Incorporated by reference to Exhibit 10.15 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.15         |   | Form of Tax Agreement Relating to S Corporation  Distributions by and between TROY Group and the Dirk Stockholders                               |   | Incorporated by reference to Exhibit 10.16 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.16         |   | Loan Agreement and Security Agreement dated October  20, 1998 between TROY Group and Comerica Bank-California                                    |   | Incorporated by reference to Exhibit 10.17 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.17         |   | Amendment No. 1 to Loan and Security Agreement  (Accounts and Inventory) dated October 28, 1999 between TROY Group and  Comerica Bank-California |   | Incorporated by reference to Exhibit 10.16 to TROY  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  1999 (File No.  000-24413). |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.18         |   | Variable Rate Installment Note dated October 20,  1998 in favor of Comerica Bank-California                                                      |   | Incorporated by reference to Exhibit 10.18 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.19         |   | Variable Rate Installment Note dated October 20,  1998 in favor of Comerica Bank-California                                                      |   | Incorporated by reference to Exhibit 10.19 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.20         |   | Acquisition Note dated October 28, 1999 in favor of  Comerica Bank – California                                                             |   | Incorporated by reference to Exhibit 10.19 to Troy  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  1999 (File No.  000-24413). |
|          |   |                                                                                                                                             |   |                                                                                                                                                                 |
| 10.21         |   | Guaranty dated October 20, 1998 by the majority  stockholders                                                                                    |   | Incorporated by reference to Exhibit 10.20 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                                 |

 

E-3

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| **Item  No.** |   | **Description**                                                                                                                                                                     |   | **Method of  Filing**                                                                                                                                          |
|---------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.22         |   | Letter dated October 3, 1997 to RAGCO from TROY  Group                                                                                                                              |   | Incorporated by reference to Exhibit 10.21 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                           |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.23         |   | Form of Subscription Agreement                                                                                                                                                      |   | Incorporated by reference to Exhibit 10.23 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                           |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.24         |   | Reseller Agreement dated April 1, 1996 between  TROY Group and Hewlett-Packard Company(1)                                                                                      |   | Incorporated by reference to Exhibit 10.24 to TROY  Group’s Registration Statement on Form S-1 (File No.  333-51523).                           |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.25         |   | Joinder Agreement dated March 3, 2000 between TROY  AMDev and Comerica Bank – California                                                                                       |   | Incorporated by reference to Exhibit 10.25 to TROY  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  2000 (File No. 000-24413). |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.26         |   | Amendment No. 2 to Loan and Security Agreement  (Accounts and Inventory) dated October 1, 2000 among TROY Group, TROY Systems  International, TROY XCD and Comerica Bank-California |   | Incorporated by reference to Exhibit 10.26 to TROY  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  2000 (File No. 000-24413). |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.27         |   | Asset Purchase Agreement, dated as of May 30, 2001,  among TROY Group, Extended Systems of Idaho and Extended Systems Incorporated                                                  |   | Incorporated by reference to Exhibit 2.1 to TROY  Group’s Current Report on Form 8-K filed on June 14, 2001 (File No.  000-24413).                        |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.28         |   | Separation Agreement and Release Letter, dated as of  November 1, 2001 between TROY Group and Robert S. Messina                                                                     |   | Incorporated by reference to Exhibit 10.28 to TROY  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  2001 (File No. 000-24413). |
|          |   |                                                                                                                                                                                |   |                                                                                                                                                           |
| 10.29         |   | Lease dated April 1, 2002 between Dirk Investments,  Inc. and TROY Group                                                                                                            |   | Filed herewith.                                                                                                                                                |

 

E-4

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| **Item  No.** |   | **Description**                                                                                         |   | **Method of  Filing**                                                                                                                                         |
|---------------|--------|---------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                    |   |                                                                                                                                                          |
| 21.1          |   | Subsidiaries of the Registrant                                                                          |   | Incorporated by reference to Exhibit 21.1 to TROY  Group’s Annual Report on Form 10-K for the fiscal year ended November 30,  2001 (File No. 000-24413). |
|          |   |                                                                                                    |   |                                                                                                                                                          |
| 23.1          |   | Consent of McGladrey & Pullen, LLP, Independent  Auditors                                           |   | Filed herewith.                                                                                                                                               |
|          |   |                                                                                                    |   |                                                                                                                                                          |
| 99.1          |   | Certification of the Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2000 |   | Filed herewith.                                                                                                                                               |
|          |   |                                                                                                    |   |                                                                                                                                                          |
| 99.2          |   | Certification of the Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2000 |   | Filed herewith.                                                                                                                                               |

 

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(1)                                  Confidentialtreatment has been requested with respect to designated portions containedwithin such document.  Such portionshave been omitted and filed separately with the Commission pursuant to Rule 406of the Securities Act of 1933, as amended.

 

E-5

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