** **

**UNITEDSTATESSECURITIES A**NDEXCHANGE COMMISSIONWashington, DC20549

** **

**FORM 10-Q**

** **
| **(Mark One)**                               |
|----------------------------------------------|
|                                         |   |
| **ý**                                   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|                                         |   |
|                                         | **For the quarterly period ended February 29, 2004.** |
|                                         |   |
| **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 Number:   000-24413** |

 

**TROY GROUP, INC.**

(Exact name of registrant 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)                           |
|                                                            |   |                                 |
| **(949) 250-3280**                                              |
| (Registrant’s telephone number, including area code)       |

 

Indicate by check mark whether the registrant (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90days.    Yes    o    No    ý

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of the SecuritiesExchange Act of 1934).    Yes    o    No    ý

 

Asof April 30, 2004, 10,642,677 shares of the Registrant’s Common Stock wereoutstanding.

 

 

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**TROY GROUP, INC.**

**Quarterly Report onForm 10-Q for the**

**Quarterly PeriodEnded February 29, 2004**

 

**INDEX**

 
| **PART I:  FINANCIAL INFORMATION** |                                                                                                                             |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                                             |   |
| Item 1.                                 | Financial Statements                                                                                                             |   |
|                                    |                                                                                                                             |   |
|                                    | Condensed Consolidated Balance Sheets  February 29, 2004 (unaudited) and November 30, 2003                                       |   |
|                                    |                                                                                                                             |   |
|                                    | Condensed Consolidated Statements of  Operations for the  Three Months ended February 29, 2004 and February 28, 2003 (unaudited) |   |
|                                    |                                                                                                                             |   |
|                                    | Condensed  Consolidated Statements of Cash Flows for the  Three Months ended February 29, 2004 and February 28, 2003 (unaudited) |   |
|                                    |                                                                                                                             |   |
|                                    | Condensed Consolidated Statement of  Stockholders’ Equity  Three Months ended February 29, 2004 (unaudited)                 |   |
|                                    |                                                                                                                             |   |
|                                    | Notes to  Condensed Consolidated Financial Statements (unaudited)                                                                |   |
|                                    |                                                                                                                             |   |
| Item 2.                                 | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                      |   |
|                                    |                                                                                                                             |   |
| Item  3.                                | Quantitative  and Qualitative Disclosures About Market Risk                                                                      |   |
|                                    |                                                                                                                             |   |
| Item 4.                                 | Controls and Procedures                                                                                                          |   |
|                                    |                                                                                                                             |   |
| **PART II:  OTHER INFORMATION**    |                                                                                                                             |
|                                    |                                                                                                                             |   |
| Item  1.                                | Legal  Proceedings                                                                                                               |   |
|                                    |                                                                                                                             |   |
| Item  4.                                | Submission  of Matters to a Vote of Security Holders                                                                             |   |
|                                    |                                                                                                                             |   |
| Item 6.                                 | Exhibits and  Reports on Form 8-K                                                                                                |   |
|                                    |                                                                                                                             |   |
| **SIGNATURE**                           |                                                                                                                             |
|                                    |                                                                                                                             |   |
| **EXHIBIT INDEX**                       |                                                                                                                             |

 

2

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**PART I:  FINANCIALINFORMATION**

 

**ITEM 1 – FINANCIAL STATEMENTS**

 

**TROYGROUP, INC.CONDENSED CONSOLIDATED BALANCESHEETS**

 

**(in thousands, exceptshare data)**

 
|                                                                                                                               |   | **February  29,  2004** |   | **November  30,  2003 (a)** |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                                                                               |   | **(Unaudited)**         |   |                        |   |
| **Assets**                                                                                                                         |   |                    |   |                        |   |
| Current assets:                                                                                                                    |   |                    |   |                        |   |
| Cash and cash equivalents                                                                                                          |   | $                       | 2,653  |                        | $      | 1,727 |   |
| Investment in available-for-sale securities                                                                                        |   | 8,000                   |   | 8,000                       |   |
| Accounts receivable, less allowance for  doubtful accounts $347 in 2004; $393 in 2003                                              |   | 8,242                   |   | 8,419                       |   |
| Inventories, net                                                                                                                   |   | 5,245                   |   | 4,891                       |   |
| Prepaid expenses and other                                                                                                         |   | 1,476                   |   | 1,414                       |   |
| Deferred tax assets                                                                                                                |   | 2,789                   |   | 2,789                       |   |
| Total current  assets                                                                                                              |   | 28,405                  |   | 27,240                      |   |
| Equipment and leasehold improvements, net                                                                                          |   | 3,278                   |   | 3,213                       |   |
| Goodwill, net                                                                                                                      |   | 281                     |   | 281                         |   |
| Receivable from stockholders                                                                                                       |   | 1,903                   |   | 1,903                       |   |
| Deferred tax assets                                                                                                                |   | 1,240                   |   | 1,330                       |   |
| Other assets                                                                                                                       |   | 959                     |   | 993                         |   |
| Total assets                                                                                                                       |   | $                       | 36,066 |                        | $      | 34,960 |   |
|                                                                                                                               |   |                    |   |                        |   |
| **Liabilities and Stockholders’ Equity**                                                                                      |   |                    |   |                        |   |
| Current liabilities:                                                                                                               |   |                    |   |                        |   |
| Accounts payable                                                                                                                   |   | $                       | 3,632  |                        | $      | 2,172 |   |
| Accrued expenses                                                                                                                   |   | 3,606                   |   | 4,322                       |   |
| Deferred revenue                                                                                                                   |   | 1,872                   |   | 1,807                       |   |
| Total current liabilities                                                                                                          |   | 9,110                   |   | 8,301                       |   |
| 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 10,642,677 shares in 2004; 10,974,170  shares in 2003 |   | 107                     |   | 110                         |   |
| Additional paid-in capital                                                                                                         |   | 19,921                  |   | 21,122                      |   |
| Accumulated other comprehensive income                                                                                             |   | 18                      |   | 33                          |   |
| Retained earnings                                                                                                                  |   | 6,918                   |   | 6,598                       |   |
|                                                                                                                               |   | 26,964                  |   | 27,863                      |   |
| Less cost of treasury stock, 2,800 shares  in 2004; 331,493 shares in 2003                                                         |   | 8                       |   | 1,204                       |   |
| Total stockholders’ equity                                                                                                    |   | 26,956                  |   | 26,659                      |   |
| Total liabilities and stockholders’ equity                                                                                    |   | $                       | 36,066 |                        | $      | 34,960 |   |

 

----

(a)           Derivedfrom the audited consolidated financial statements for the year ended November30, 2003

 

See Notes to Condensed Interim Consolidated Financial Statements.

 

3

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**TROY GROUP, INC.**

**CONDENSED CONSOLIDATED STATEMENTS**

**OF OPERATIONS**

**(Unaudited)**

**(in thousands, exceptper share amounts)**

 
|                                   |   | **Three  Months Ended** |   |
|----------------------------------------|--------|-------------------------|--------|
|                                   |   | **February  29,  2004** |   | **February  28,  2003** |   |
|                                   |   |                    |   |   |   |
| Net sales                              |   | $                       | 13,617 |   | $ | 14,408 |   |
| Cost of goods sold                     |   | 8,273                   |   | 8,438 |   |
| Gross profit                           |   | 5,344                   |   | 5,970 |   |
|                                   |   |                    |   |   |   |
| Operating expenses:                    |   |                    |   |   |   |
| Selling, general and administrative    |   | 3,590                   |   | 4,007 |   |
| Research and development               |   | 1,237                   |   | 1,462 |   |
| Amortization of intangible assets      |   | 27                      |   | 33 |   |
| Operating income                       |   | 490                     |   | 468 |   |
|                                   |   |                    |   |   |   |
| Interest income                        |   | 30                      |   | 3 |   |
| Interest expense                       |   | —                  |   | (2 | ) |
| Income before income taxes             |   | 520                     |   | 469 |   |
| Provision for income taxes             |   | 200                     |   | 187 |   |
| Net income                             |   | $                       | 320    |   | $ | 282 |   |
|                                   |   |                    |   |   |   |
| Net income per share:                  |   |                    |   |   |   |
| Basic                                  |   | $                       | .03    |   | $ | .03 |   |
| Diluted                                |   | $                       | .03    |   | $ | .03 |   |
|                                   |   |                    |   |   |   |
| Shares used in per share computations: |   |                    |   |   |   |
| Basic                                  |   | 10,643                  |   | 10,649 |   |
| Diluted                                |   | 10,648                  |   | 10,649 |   |

 

See Notes to Condensed Interim Consolidated Financial Statements.

 

4

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**TROY GROUP, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS**

**OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

** **
|                                                                                         |   | **Three  Months Ended** |   |
|----------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                         |   | **February  29,  2004** |   | **February  28,  2003** |   |
|                                                                                         |   |                    |   |   |   |
| **Cash flows provided by (used in) operating activities:**                                   |   |                    |   |   |   |
| Net income provided by (used in)                                                             |   | $                       | 320    |   | $ | 282 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |   |                    |   |   |   |
| Depreciation and amortization                                                                |   | 195                     |   | 316 |   |
| Provision for (recovery of) doubtful  accounts                                               |   | (45                     | )      | 27 |   |
| Changes in working capital components:                                                       |   |                    |   |   |   |
| (Increase) decrease in:                                                                      |   |                    |   |   |   |
| Accounts receivable                                                                          |   | 223                     |   | (1,037 | ) |
| Inventories                                                                                  |   | (354                    | )      | (629 | ) |
| Prepaid expenses and other                                                                   |   | (63                     | )      | 344 |   |
| Deferred taxes                                                                               |   | 90                      |   | — |   |
| Increase (decrease) in:                                                                      |   |                    |   |   |   |
| Accounts payable                                                                             |   | 1,461                   |   | (233 | ) |
| Accrued expenses                                                                             |   | (716                    | )      | 296 |   |
| Deferred revenue                                                                             |   | 65                      |   | (82 | ) |
| Net cash provided by (used in) operating  activities                                         |   | 1,176                   |   | (716 | ) |
|                                                                                         |   |                    |   |   |   |
| **Cash flows used in investing activities:**                                                 |   |                    |   |   |   |
| Purchase of equipment and leasehold  improvements                                            |   | (189                    | )      | (18 | ) |
| Maturities of available-for-sale securities                                                  |   | —                  |   | 497 |   |
| (Increase) decrease in other assets, net                                                     |   | (38                     | )      | (598 | ) |
| Net cash used in investing activities                                                        |   | (227                    | )      | (119 | ) |
|                                                                                         |   |                    |   |   |   |
| **Cash flows used in financing activities:**                                                 |   |                    |   |   |   |
| Payments on notes payable                                                                    |   | —                  |   | (18 | ) |
| Purchase of treasury stock                                                                   |   | (8                      | )      | — |   |
| Net cash used in financing activities                                                        |   | (8                      | )      | (18 | ) |
|                                                                                         |   |                    |   |   |   |
| **Net decrease in accumulated other  comprehensive income**                                  |   | (15                     | )      | — |   |
|                                                                                         |   |                    |   |   |   |
| **Net increase (decrease) in cash and cash equivalents**                                     |   | 926                     |   | (853 | ) |
| **Cash and cash equivalents, beginning of period**                                           |   | 1,727                   |   | 6,615 |   |
| **Cash and cash equivalents, end of period**                                                 |   | $                       | 2,653  |   | $ | 5,762 |   |

 

See Notes to Condensed Interim Consolidated Financial Statements.

 

5

----

 

**TROYGROUP, INC.**

** **

**CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**((Unaudited)**

**(inthousands except share amounts)**

** **
|                                                |   |              |   |           |   |        |   | **Accumulated**   |   |                |   |          |   |       |   |                   |   |               |   |
|-----------------------------------------------------|--------|-------------------|--------|----------------|--------|-------------|--------|-------------------|--------|---------------------|--------|---------------|--------|------------|--------|------------------------|--------|--------------------|--------|
|                                                |   | **Common  Stock** |   | **Additional** |   | **Other**   |   |              |   | **Treasury  Stock** |   | **Total**     |   |       |   |
|                                                |   | **Number**        |   |           |   | **Paid-in** |   | **Comprehensive** |   | **Retained**        |   | **Number**    |   |       |   | **Stockholders’** |   | **Comprehensive**  |   |
|                                                |   | **of Shares**     |   | **Amount**     |   | **Capital** |   | **Income**        |   | **Earnings**        |   | **of Shares** |   | **Amount** |   | **Equity**             |   | **Income  (Loss)** |   |
|                                                |   |              |   |           |   |        |   |              |   |                |   |          |   |       |   |                   |   |               |   |
| Balance, November 30, 2003                          |   | 10,974,170        |   | $              | 110    |        | $      | 21,122            |   | $                   | 33     |          | $      | 6,598      |   | 331,493                |   | $                  | (1,204 | ) | $ | 26,659 |   | $ | — |   |
| Retirement of treasury stock                        |   | (331,493          | )      | (3             | )      | (1,201      | )      | —            |   | —              |   | (331,493      | )      | 1,204      |   | —                 |   | —             |   |
| Purchase of common stock for the treasury           |   | —            |   | —         |   | —      |   | —            |   | —              |   | 2,800         |   | (8         | )      | (8                     | )      | —             |   |
| Foreign currency translation adjustment, net of tax |   | —            |   | —         |   | —      |   | (15               | )      | —              |   | —        |   | —     |   | (15                    | )      | (15                | )      |
|                                                |   |              |   |           |   |        |   |              |   |                |   |          |   |       |   |                   |   |               |   |
| Net income                                          |   | —            |   | —         |   | —      |   | —            |   | 320                 |   | —        |   | —     |   | 320                    |   | 320                |   |
| Balance, February 29, 2004                          |   | 10,642,677        |   | $              | 107    |        | $      | 19,921            |   | $                   | 18     |          | $      | 6,918      |   | 2,800                  |   | $                  | (8     | ) | $ | 26,956 |   | $ | 305 |   |

** **

**SeeNotes to Condensed Interim Consolidated Financial Statements**

 

6

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**TROY GROUP, INC.**

**NOTES TO CONDENSEDINTERIM CONSOLIDATED**

**FINANCIAL STATEMENTS**

(unaudited)

 

**Note 1. Basis of Presentation**

 

The accompanying unauditedconsolidated financial statements of TROY Group, Inc. (the “Company”) have beenprepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals andadjustments) considered necessary for a fair presentation have beenincluded.  Operating results for thethree months ended February 29, 2004 are not necessarily indicative of theresults that may be expected for the year ending November 30, 2004.  For further information, refer to theconsolidated financial statements and footnotes thereto included in theCompany’s Annual Report on Form 10-K for its fiscal year ended November 30,2003.

 

Statement of Financial AccountingStandards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” as amendedby SFAS No. 148, “Accounting for Stock-Based Compensation – Transition andDisclosure,” prescribes accounting and reporting standards for all stock-basedcompensation plans, including employee stock option plans. As allowed by SFASNo. 123, the Company has elected to continue to account for its employeestock-based compensation plan using the intrinsic value method in accordancewith Accounting Principles Board (APB) Opinion No. 25, “Accounting for StockIssued to Employees,” and related Interpretations, which does not requirecompensation to be recorded if the consideration to be received is at leastequal to the fair value of the common stock to be received at the measurementdate. Under the requirements of SFAS No. 123, non-employee stock-basedtransactions require compensation to be recorded based on the fair value of thesecurities issued or the services received, whichever is more reliablymeasurable.

 

The following table illustrates theeffect on net income and net income per share had compensation costs for thestock-based compensation plan been determined based on the fair values ofawards on the grant date under the provisions of SFAS No. 123, for thethree-month periods ended February 29, 2004 and February 28, 2003 (unaudited;in thousands, except per share data):

 
|                                                                                                                                       |   | **Three  months ended** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                                                                                       |   | **February  29,  2004** |   | **February  28,  2003** |   |
| Net income applicable to common  stockholders                                                                                         |   |                    |   |   |   |
| As reported                                                                                                                                |   | $                       | 320    |   | $ | 282 |   |
| Less total stock-based employee  compensation expense determined under fair value-based method for all awards,  net of related tax effects |   | (170                    | )      | (216 | ) |
| Proforma                                                                                                                                   |   | $                       | 150    |   | $ | 66 |   |
|                                                                                                                                       |   |                    |   |   |   |
| Net income per share applicable to common  stockholders, basic and diluted:                                                                |   |                    |   |   |   |
| As reported                                                                                                                                |   | $                       | .03    |   | $ | .03 |   |
| Proforma                                                                                                                                   |   | $                       | .01    |   | $ | .01 |   |

 

The fair value of each optiongrant was estimated on the date of grant using the Black-Scholes option-pricingmodel with the following assumptions used for grants during the quarter endedFebruary 29, 2004.

 
| Risk free  interest rate |   | 0.9% and 3.3% |   |
|--------------------------|--------|---------------|--------|
| Expected  life           |   | 10 years      |   |
| Expected  volatility     |   | 28%           |   |

 

7

----

 

**Note 2. Inventories**

 

Inventories consisted of thefollowing as of February 29, 2004 and November 30, 2003 (amounts in thousands):

 
|                                              |   | **February  29, 2004** |   | **November  30, 2003** |   |
|---------------------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                              |   | **(unaudited)**        |   |                   |   |
| Raw materials                                     |   | $                      | 4,210  |                   | $      | 4,671 |   |
| Work-in-process                                   |   | 608                    |   | 401                    |   |
| Finished goods                                    |   | 2,794                  |   | 2,264                  |   |
| Reserve for slow moving and obsolete  inventories |   | (2,367                 | )      | (2,445                 | )      |
| Total                                             |   | $                      | 5,245  |                   | $      | 4,891 |   |

 

**Note3.  Other Assets**

 

Other assets consisted of the following at February29, 2004 and November 30, 2003 (amounts in thousands):

** **
|                                                                                 |   | **February  29, 2004** |   | **November  30, 2003** |   |
|--------------------------------------------------------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                                                                 |   | **(unaudited)**        |   |                   |   |
| Customer list, net of accumulated  amortization  2004 $21 and 2003 $20               |   | $                      | 4      |                   | $      | 5 |   |
| Core technology, net of accumulated  amortization  2004 $254 and 2003 $236           |   | 138                    |   | 156                    |   |
| Purchased software, net of accumulated  amortization  2004 $128 and 2003 $120        |   | 5                      |   | 13                     |   |
| Software development costs, net of  accumulated amortization 2004 $404 and 2003 $359 |   | 314                    |   | 359                    |   |
| Cash surrender value of officers’ life  insurance                               |   | 498                    |   | 460                    |   |
| Unsecured receivable from stockholders                                               |   | 1,903                  |   | 1,903                  |   |
| Long-term deferred tax assets                                                        |   | 1,240                  |   | 1,330                  |   |
|                                                                                 |   | $                      | 4,102  |                   | $      | 4,226 |   |
|                                                                                      |        |                        |        |                        |        |  |  |  |

** **

**Note 4. Goodwill and Intangible Assets**

 

The Company adopted SFASNo. 142 *Goodwill and Other IntangibleAssets*effective December 1, 2002 and performed the initialtransitional impairment test as of that date. The provisions of SFASNo. 142 require that the Company allocate its goodwill to its variousreporting units, determine the carrying value of those businesses, and estimate thefair value of the reporting units so that a two-step goodwill impairment testcan be performed. The Company’s reporting units represent components of itsoperating segments, which are the same as the reportable segments, identifiedin Note 9. In the first step of the goodwill impairment test, the fairvalue of each reporting unit is compared to its carrying value. If the fairvalue exceeds the carrying value, goodwill is not impaired and no furthertesting is performed. If the carrying value exceeds the fair value, then thesecond step must be performed, and the implied fair value of the reportingunit’s goodwill must be determined and compared to the carrying value of thegoodwill for the reporting unit. If the carrying value of a reporting unit’sgoodwill exceeds its implied fair value, then an impairment loss equal to thedifference is recorded.

 

For the year ended November 30, 2003, no impairment loss wasrecognized. However, future goodwill impairment tests could result in a chargeto earnings. The Company will continue to evaluate goodwill on an annual basisas of the beginning of the fourth fiscal quarter, and whenever events andchanges in circumstances indicate that there may be a potential impairment.

 

On December 1, 2002, the Company completed the allocation ofgoodwill (including amounts previously classified as assembled workforce) toits reportable segments as part of its transitional impairment test. Goodwillallocated to the Company’s reportable segments as of November 30, 2003 andFebruary 29, 2004 are as follows (amounts in thousands):

 
|                                     |   | **Wireless  &  Connectivity** |   | **Secure  Payment  Systems** |   | **Total** |   |
|------------------------------------------|--------|-----------------------------------|--------|------------------------------|--------|-----------|--------|
| Balance at November 30, 2003             |   | $                                 | — |                         | $      | 281       |   | $ | 281 |   |
| Balance at February 29, 2004 (unaudited) |   | $                                 | — |                         | $      | 281       |   | $ | 281 |   |

 

The Company’s intangible assets subject to amortization atFebruary 29, 2004 and November 30, 2003 are composed of (amounts in thousands):

 
|                                 |   | **February 29, 2004** |   | **November 30, 2003**         |   |
|--------------------------------------|--------|-----------------------|--------|-------------------------------|--------|
|                                 |   | **(unaudited)**       |   |                          |   |   |   |   |   |
|                                 |   | **Gross**             |   | **Accumulated  Amortization** |   | **Net** |   | **Gross** |   | **Accumulated  Amortization** |   | **Net** |   |
| Customer  Lists                      |   | $                     | 25     |                          | $      | (21 | ) | $ | 4 |   | $ | 25 |   | $ | (20 | ) | $ | 5 |   |
| Core  Technology                     |   | 392                   |   | (254                          | )      | 138 |   | 392 |   | (236 | ) | 156 |   |
| Purchased  Software                  |   | 133                   |   | (128                          | )      | 5 |   | 133 |   | (120 | ) | 13 |   |
|                                 |   |                  |   |                          |   |   |   |   |   |   |   |   |   |
| Total  amortizable intangible assets |   | $                     | 550    |                          | $      | (403 | ) | $ | 147 |   | $ | 550 |   | $ | (376 | ) | $ | 174 |   |
|                                 |   |                  |   |                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

8

----

 

Amortization expense related to intangible assets wasapproximately $27,000 and $33,000 for each of the three-month periods endedFebruary 29, 2004 and February 28, 2003, respectively.

 

Estimated future amortization expense related to purchasedintangible assets at February 29, 2004 is as follows:

 
| **Fiscal year:** |   | **(In  thousands)** |   |
|------------------|--------|---------------------|--------|
| 2004             |   | $                   | 61     |   |
| 2005             |   | 86                  |   |
| Total            |   | $                   | 147    |   |

 

**Note5. Notes Payable**

 

The Company has a $5.0 million line-of-creditagreement with Comerica Bank.  As ofFebruary 29, 2004, there were no borrowings outstanding against the line ofcredit.  Borrowings under the line ofcredit bear interest at the lesser of the bank’s reference rate (4.00 % atFebruary 29, 2004) less 0.25% or the bank’s LIBOR rate (1.10 % at February 29,2004) plus 2% and are limited to 80% of eligible accounts receivable and 50% ofeligible inventories if total liabilities to tangible effective net worth is greaterthan two to one.  No formula is requiredif total liabilities to tangible effective net worth is less than two to one.In connection with the line-of-credit agreement, the Company has a $650,000standby letter-of-credit sub-limit, of which approximately $80,000 wasoutstanding at February 29, 2004.  Thisline of credit is secured by substantially all of the Company’s assets.  The borrowing arrangement requires theCompany to comply with certain financial covenants and other restrictions,including its ability to pay dividends, and as of February 29, 2004 the Companywas in compliance with those convenants. As of February 29, 2004, the Companyhad approximately $4.9 million in availability under the line of credit.  The line-of-credit borrowings are due ondemand. The agreement may be terminated by either party at any time.

 

**Note 6. Stock Option and Stock Warrant Plans**

 

During the three months endedFebruary 29, 2004, the Company granted 40,000 stock options to employees and adirector. The following is a summary of total outstanding options and stockwarrants at February 29, 2004:

 
|                          |   | **Options  and Warrants Outstanding** |   |                                   |   |
|-------------------------------|--------|---------------------------------------|--------|----------------------------------------|--------|
|                          |   |                                  |   |                                   |   | **Weighted-** |   | **Options  and Warrants Exercisable** |   |
| **Range of  Exercise Prices** |   | **Number of  Shares**                 |   | **Weighted-  Average  Exercise Price** |   | **Average  Remaining  Contractual Life** |   | **Number of  Shares** |   | **Weighted-  Average  Exercise Price** |   |
| $2.85 -  $4.51                |   | 702,666                               |   | $                                      | 3.87   |   | 6.4 years |   | 429,914 |   | $ | 3.82 |   |
| 6.63 - 8.75                   |   | 461,000                               |   | 7.32                                   |   | 5.8 years |   | 379,154 |   | 7.33 |   |
| 13.16 -  14.25                |   | 15,000                                |   | 13.52                                  |   | 6.0 years |   | 9,998 |   | 13.52 |   |
| $2.85 -  $14.25               |   | 1,178,666                             |   | $                                      | 5.34   |   | 6.2 years |   | 819,066 |   | $ | 5.56 |   |

 

At February 29, 2004, therewere 1,618,000 shares remaining available for grant under the Company’s stockoption plan.

 

9

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**Note 7. Net Income Per Share**

 

The following table sets forth thecomputation of basic and diluted net loss per share(unaudited; in thousands,except per share data):

 
|                                                   |   | **Three  months ended** |   |
|--------------------------------------------------------|--------|-------------------------|--------|
|                                                   |   | **February  29,  2004** |   | **February  28,  2003** |   |
| Numerator for basic and diluted net income  per share: |   |                    |   |   |   |
| Net income                                             |   | $                       | 320    |   | $ | 282 |   |
|                                                   |   |                    |   |   |   |
| Denominator for basic net income per share             |   |                    |   |   |   |
| Weighted-average shares outstanding                    |   | 10,643                  |   | 10,649 |   |
| Effect of employee stock options and  warrants         |   | 5                       |   | — |   |
|                                                   |   |                    |   |   |   |
| Denominator for diluted net income per  share          |   | 10,648                  |   | 10,649 |   |
|                                                   |   |                    |   |   |   |
| Net income per share:                                  |   |                    |   |   |   |
| Basic                                                  |   | $                       | .03    |   | $ | .03 |   |
| Diluted                                                |   | $                       | .03    |   | $ | .03 |   |

 

## **Note 8. Contractual Obligations and Commercial Commitments**

## ** **

We havethe following minimum noncancellable contractual obligations and commercialcommitments. (amounts in thousands):

 
|                               |   | **Total** |   | **Fiscal  2004** |   | **Fiscal  2005-07** |   | **Fiscal  2008** |   |
|------------------------------------|--------|-----------|--------|------------------|--------|---------------------|--------|------------------|--------|
| Related party operating lease      |   | $         | 1,167  |             | $      | 215                 |   | $                | 857    |   | $ | 95 |   |
| Other operating leases             |   | 264       |   | 149              |   | 115                 |   | —           |   |
| Split dollar life insurance policy |   | **        |   | **               |   | **                  |   | **               |   |
| Total                              |   | $         | 1,431  |             | $      | 364                 |   | $                | 972    |   | $ | 95 |   |

 

The annual commitments reflected in the table above are basedon our November 30 year-end.

 

----

**We previously had committed tomaking payments on the split dollar life insurance policy based on continuedemployment. As of February 29, 2004 and November 30, 2003, we had a balance ofadvanced payments of  $1,903,000 toaffiliated stockholders in connection with the purchase of split dollar lifeinsurance policies.  The Company and thestockholders have executed split-dollar agreements governing the unsecurednon-interest bearing advances. The advances are due upon the death, terminationor retirement of the Company’s Chairman, Chief Executive Officer and majoritystockholder.  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 we have not funded the annual premiumpayments on these policies.  If the SECissues new regulations or other guidance that causes us to reevaluate ourposition, we may demand payment on the advance and terminate our participationin these arrangements.

 

## **Note 9.  MajorVendors**

 

The Company purchases keycomponents from a vendor and also sells products to this same vendor.  Purchases from this vendor for the threemonths ended February 29, 2004 and February 28, 2003 were (in thousands):$2,603, and $2,090, respectively.  Netpayable balances to this vendor as of February 29, 2004 and November 30, 2003were (in thousands): $608 and $149, respectively.

 

**Note10. Major Customers**

 

In the first three months offiscal 2004, the Company recorded sales to one customer of $1.5 million, whichis 11% of net sales.  The accountsreceivable balance due from this customer at February 29, 2004 was $1.2million.  There were no customers thataccounted for 10% or more of net sales in fiscal 2003.

 

10

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**Note 11. Segment Information and Geographical Information**

 

*Segment Information*

 

The following tables summarizenet sales and net income by the Company’s operating segments, Secure PaymentSystems and Wireless and Connectivity Solutions, for the three months endedFebruary 29, 2004 and February 28, 2003:

 
|                                |   | **Three  months ended**                |   |
|-------------------------------------|--------|----------------------------------------|--------|
|                                |   | **(amounts  in thousands)(unaudited)** |   |
|                                |   | **February  29,  2004**                |   | **February  28,  2003** |   |
| Net sales:                          |   |                                   |   |   |   |
| Secure Payment Systems              |   | $                                      | 9,507  |   | $ | 10,339 |   |
| Wireless and Connectivity Solutions |   | 4,110                                  |   | 4,069 |   |
|                                |   | $                                      | 13,617 |   | $ | 14,408 |   |
|                                |   |                                   |   |   |   |
| Net income:                         |   |                                   |   |   |   |
| Secure Payment Systems              |   | $                                      | 4      |   | $ | 264 |   |
| Wireless and Connectivity Solutions |   | 316                                    |   | 18 |   |
|                                |   | $                                      | 320    |   | $ | 282 |   |

 
|                                |   | **February  29, 2004**                 |   | **November  30, 2003**      |   |
|-------------------------------------|--------|----------------------------------------|--------|-----------------------------|--------|
|                                |   | **(amounts  in thousands)(unaudited)** |   | **(amounts  in thousands)** |   |
| Segment Assets:                     |   |                                   |   |                        |   |
| Secure Payment Systems              |   | $                                      | 30,657 |                        | $      | 29,083 |   |
| Wireless and Connectivity Solutions |   | 10,920                                 |   | 11,281                      |   |
|                                |   | $                                      | 41,577 |                        | $      | 40,364 |   |

 

The following schedule ispresented to reconcile February 29, 2004 and November 30, 2003 segment assetsto the amounts reported in the Company’s consolidated financial statements(amounts in thousands).

 
|                                |   | **February  29, 2004**                 |   | **November  30, 2003**      |   |
|-------------------------------------|--------|----------------------------------------|--------|-----------------------------|--------|
|                                |   | **(amounts  in thousands)(unaudited)** |   | **(amounts  in thousands)** |   |
| Total assets of reportable segments |   | $                                      | 41,577 |                        | $      | 40,364 |   |
| Intersegment receivables            |   | (5,277                                 | )      | (5,170                      | )      |
| Investment in subsidiaries          |   | (234                                   | )      | (234                        | )      |
| Consolidated assets                 |   | $                                      | 36,066 |                        | $      | 34,960 |   |

 

*GeographicalInformation*

 
|                |   | **Three  months ended**                |   |
|---------------------|--------|----------------------------------------|--------|
|                |   | **(amounts  in thousands)(unaudited)** |   |
|                |   | **February  29,  2004**                |   | **February  28,  2003** |   |
| Net sales:          |   |                                   |   |   |   |
| United States       |   | $                                      | 10,768 |   | $ | 11,551 |   |
| All Other Countries |   | 2,849                                  |   | 2,857 |   |
|                |   | $                                      | 13,617 |   | $ | 14,408 |   |

 

11

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**Note 12. Cash Flow Information**

 

Supplemental disclosure of cashflow information

 
|                                             |   | **Three  months ended**                |   |
|--------------------------------------------------|--------|----------------------------------------|--------|
|                                             |   | **(amounts  in thousands)(unaudited)** |   |
|                                             |   | **February  29,  2004**                |   | **February  28,  2003** |   |
| Cash paid during the period for:                 |   |                                   |   |   |   |
| Interest                                         |   | $                                      | — |   | $ | 2 |   |
| Income taxes                                     |   | $                                      | 70     |   | $ | 127 |   |
| Supplemental Disclosure of  Non-Cash Activities: |   |                                   |   |   |   |   |   |
| Retirement of treasury stock                     |   | $                                      | 1,204  |   | $ | — |   |

 

**Note13.****Income Taxes**

 

Deferred taxes are provided on a liabilitymethod whereby deferred tax assets are recognized for deductible temporarydifferences and operating loss and tax credit carryforwards and deferred taxliabilities are recognized for taxable temporary differences.  Temporary differences are the differencesbetween the reported amounts of assets and liabilities and their taxbases.  Deferred tax assets are reducedby a valuation allowance when it is determined to be more likely than not thatsome portion or all of the deferred tax assets will not be realized. Inevaluating the need for a valuation allowance, the Company considers futuretaxable income and prudent and feasible tax planning strategies. The Companyhas placed substantial reliance on its current projections of future taxableincome.  The Company re-assesses itsprojections of taxable income on a quarterly basis.  If it is determined that the Company would not be able to realizeall or part of its deferred tax assets in the future, which would include theCompany’s failure to materially meet its projections of taxable income, anadjustment to the carrying value of the deferred tax assets would be charged toincome in the period in which such determination was made and may affect ourannual effective income tax rate. 

 

Management currently believes the deferredtax assets are more likely than not to be realized based on currentexpectations of future earnings and available tax planning strategies.  Deferred tax assets and liabilities areadjusted for the effects of changes in tax laws and rates on the date ofenactment.

 

The net deferred tax assets have beenclassified on the accompanying consolidated balance sheets as follows (inthousands):

 
|             |   | **February  29,  2004** |   | **November  30,  2003** |   |
|------------------|--------|-------------------------|--------|-------------------------|--------|
|             |   |                    |   |                    |   |
| Current assets   |   | $                       | 2,789  |                    | $      | 2,789 |   |
| Long-term assets |   | 1,240                   |   | 1,330                   |   |
|             |   | $                       | 4,029  |                    | $      | 4,119 |   |

 

12

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**ITEM 2.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion and analysisshould be read in conjunction with our Consolidated Financial Statements andrelated Notes included in this report. This report contains forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995.  The statements contained in this report that are not historicalin nature, particularly those that utilize terminology such as “may,” “will,”“should,” “expects,” “anticipates,” “estimates,” “believes” or “plans,” orcomparable terminology, are forward-looking statements based on currentexpectations and assumptions. * Such forward looking statements include, butare not limited to, statements regarding the useful life of our products,future costs of goods sold, fluctuations in gross profits, expenditures onresearch and development, consolidation of leasing entity, the development andrelease of new products and technologies, benefits from enhancements toexisting products and technologies, future revenues and costs and capital andfinancing requirements, international sales, impact on the market price of ourcommon stock, compliance with laws and regulations, changes in the value of ourfinancial instruments and benefits of our ERP system.*

 

Variousrisks and uncertainties could cause actual results to differ materially fromthose expressed in forward-looking statements. These risks and uncertainties include, but are not limited to, thecontinued demand for printed financial documents; our ability to offset theexpected decline in sales of our wired connectivity products; the marketacceptance of products incorporating wireless printing technologies; 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.  These forward-looking statements speak only as of the datehereof.  We expressly disclaim anyobligation or undertaking to release publicly any updates or revisions to anyforward-looking statements contained herein to reflect any change in ourexpectations with regard thereto or any change in events, conditions orcircumstances on which any such statement is based.

 

We own or have rights to trademarksthat we use in connection with the sale of our products.  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.

 

All references to “TROY,” “we,” “us” or “our” means TROYGroup, Inc. and its subsidiaries, except where it is made clear that the termmeans only the parent company.

 

**Recent Developments**

 

As disclosed in ourreport on Form 8-K filed March 26, 2004, as amended on Form 8-K/A filed April7, 2004, on March 22, 2004, the Audit Committee of our Board of Directorsapproved a change in our independent accountants for the fiscal year endingNovember 30, 2004.  The Board ofDirectors ratified the Audit Committees’ dismissal of McGladrey & Pullen,LLP and the selection of BDO Seidman, LLP as our independent accountants.

 

13

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**Background**

 

TROY offers a full range of productsto its customers in two primary product lines: Secure Payment Systems andWireless and Connectivity Solutions. Secure Payment Systems include SecurityPrinting Solutions, which enable the secure printing and management of checks,and Financial Service Solutions, which enable secure electronic payments.Wireless and Connectivity Solutions includes hardware and software solutionsthat enable enterprises to share intelligent devices, such as printers, eitherwirelessly or using traditional networks.

 

Our products have been adopted by awide variety of industries including electronic bill payment utilities, retailand brokerage firms, telecommunications, financial services, insurance,computer hardware, automotive, personnel and others.  We market our products in 55 countries and have more than 7,000active customers.  In the first threemonths of fiscal 2004, there was one customer who accounted for 11% of our netsales.

 

**Results of Operations**

 

The following table sets forth, forthe periods indicated, certain information derived from our consolidatedstatements of operations expressed as a percentage of net sales:

 
|                                          |   | **Three  Months Ended February 29,** |   |
|-----------------------------------------------|--------|--------------------------------------|--------|
|                                          |   | **2004**                             |   | **2003** |   |
| Net sales                                     |   | 100.0                                | %      | 100.0 | % |
| Cost of goods sold                            |   | 60.8                                 |   | 58.6 |   |
| Gross profit                                  |   | 39.2                                 |   | 41.4 |   |
| Selling, general and administrative  expenses |   | 26.4                                 |   | 27.9 |   |
| Research and development expenses             |   | 9.0                                  |   | 10.1 |   |
| Amortization of intangible assets             |   | 0.2                                  |   | 0.2 |   |
| Operating income                              |   | 3.6                                  |   | 3.2 |   |
| Interest income                               |   | 0.2                                  |   | 0.1 |   |
| Interest expense                              |   | —                               |   | — |   |
| Income before income taxes                    |   | 3.8                                  |   | 3.3 |   |
| Provision for income taxes                    |   | 1.5                                  |   | 1.3 |   |
| Net income                                    |   | 2.3                                  | %      | 2.0 | % |

 

**Three Months Ended February 29, 2004 Comparedto Three Months Ended February 28, 2003**

 

*Net Sales.*Net sales in the three months endedFebruary 29, 2004 decreased by $0.8 million, or 5.5%, to $13.6 million from$14.4 million in the three months ended February 28, 2003.  The decrease in sales was primarily due to a$0.4 million decrease in revenue from our financial services software and a$0.4 million decrease in our security printing solutions products, both in ourSecure Payments Systems segment. The decrease in financial services softwarerevenue resulted from completion of a large installation of StarACH software inthe first quarter of fiscal 2003 which did not occur in the first quarter offiscal 2004.  The decline in SecurityPrinting Solutions sales was due to reduced demand for MICR printers andsupplies in the first quarter of fiscal 2004 versus fiscal 2003. Net sales werenot significantly affected by price changes.

 

14

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*Net Sales byProduct Segment*

 
|                                |   | **Three  months ended**    |   |
|-------------------------------------|--------|----------------------------|--------|
|                                |   | **(amounts  in millions)** |   |
|                                |   | **February  29,  2004**    |   | **February  28,  2003** |   | **Percent  Change** |   |
| Net sales:                          |   |                       |   |   |   |   |   |
| Secure Payment Systems              |   | $                          | 9.5    |   | $ | 10.3 |   | (8.0 | )% |
| Wireless and Connectivity Solutions |   | 4.1                        |   | 4.1 |   | 1.0 | % |
|                                |   | $                          | 13.6   |   | $ | 14.4 |   | (5.5 | )% |

 

*Gross Profit.*

 

Gross profit,related percent changes and percent of total sales are as follows: 

 
|         |   | **Three  months ended**    |   | **Percent of  Total Sales** |   |
|--------------|--------|----------------------------|--------|-----------------------------|--------|
|         |   | **(amounts  in millions)** |   |                        |   |   |   |
|         |   | **February  29,  2004**    |   | **February  28,  2003**     |   | **Percent  Change** |   | **February  29,  2004** |   | **February  28,  2003** |   |
| Gross profit |   | $                          | 5.3    |                        | $      | 6.0 |   | (10.5 | )% | 39.2 | % | 41.4 | % |
|              |        |                            |        |                             |        |  |  |  |  |  |  |  |  |

 

Gross profit decreased in the threemonths ended February 29, 2004 from the three months ended February 28, 2003,primarily due to decreased sales of Secure Payment Systems products describedabove, and a shift in mix toward lower margin products. Gross profit as apercent of sales will fluctuate based on shifts in the mix of productssold.  Gross profit was not significantlyaffected by price changes.

 

*Selling, General and Administrative Expenses*.

 

Selling, general and administrativeexpenses, related percent changes and percent of total sales are as follows: 

 
|                                          |   | **Three  months ended**    |   |                        |   |
|-----------------------------------------------|--------|----------------------------|--------|-----------------------------|--------|
|                                          |   | **(amounts  in millions)** |   | **Percent of  Total Sales** |   |
|                                          |   | **February  29,  2004**    |   | **February  28,  2003**     |   | **Percent  Change** |   | **February  29,  2004** |   | **February  28,  2003** |   |
| Selling, general and administrative  expenses |   | $                          | 3.6    |                        | $      | 4.0 |   | (10.4 | )% | 26.4 | % | 27.9 | % |
|                                               |        |                            |        |                             |        |  |  |  |  |  |  |  |  |

 

The decrease in selling, general andadministrative expenses was primarily due to cost savings from reductions instaff and foreign currency translation gains. General and administrativeexpenses in the first quarter of fiscal 2004 included  $0.6 million in professional fees related to the year-end auditand the implementation of the new ERP system. General and administrativeexpenses in the first quarter of fiscal 2003 included  $0.7 million in professional fees related to the year-end auditand the proposed merger to take TROY private.

 

*Research and Development Expenses*.

 

Research and development expenses,related percent changes and percent of total sales are as follows:

 
|                              |   | **Three  months ended**    |   |                        |   |
|-----------------------------------|--------|----------------------------|--------|-----------------------------|--------|
|                              |   | **(amounts  in millions)** |   | **Percent of  Total Sales** |   |
|                              |   | **February  29,  2004**    |   | **February  28,  2003**     |   | **Percent  Change** |   | **February  29,  2004** |   | **February  28,  2003** |   |
| Research and development expenses |   | $                          | 1.2    |                        | $      | 1.5 |   | (15.4 | )% | 9.0 | % | 10.1 | % |
|                                   |        |                            |        |                             |        |  |  |  |  |  |  |  |  |

 

15

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Research and development expensesdecreased in the three months ended February 29, 2004 compared to the threemonths ended February 29, 2003, primarily due to reduced spending for SecurePayment Systems products.  The totalresearch and development expenses for the first quarter of fiscal 2004 included$0.8 million for Secure Payment Systems and $0.4 million for Wireless andConnectivity Solutions. We have the ability to redirect our research anddevelopment activities 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 thecommercialization of any of our development efforts is not currently known.

 

*Amortization of Intangible Assets. *Amortization of intangible assetsdecreased by $6,000 to $27,000 in the three months ended February 29, 2004 from$33,000 in the three months ended February 29, 2004, due to some assetsbecoming fully amortized in fiscal year 2003.

 

*Operating Income*. As a result of the above factors, operating income increased by $22,000to $490,000 in the three months ended February 29, 2004 from $468,000 in thethree months ended February 28, 2003. The operating income as a percentage of net sales was 3.6% in the threemonths ended February 29, 2004 compared to 3.2% in the three months endedFebruary 28, 2003.

 

*Interest Income.* Interest income increased by $27,000 to $30,000 in the three monthsended February 28, 2003 from $3,000 in the three months ended February 28,2003.  This increase was the result ofincreases in our investment in available-for-sale securities.

 

*Interest Expense*. There was no interest expense in the three months ended February 29,2004 compared to $2,000 in the three months ended February 28, 2003, due to thepayment of the note payable in fiscal 2003.

 

*Income Taxes*. Income tax expense was $0.2 million in the three months ended February29, 2004 and in the three months ended February 28, 2003.  Income tax expense as a percentage of pretaxincome was 38.5% in the three months ended February 29, 2004 compared to 39.9%in the three months ended February 28, 2003. The decrease in the effective tax rate in fiscal 2004 compared to fiscal2003 was primarily due to a lower proportion in fiscal 2004 of foreign sourceincome which has a higher effective tax rate.

 

**Liquidity and Capital Resources**

 

Cash flows provided by operating activitieswere $1.2 million in the three months ended February 29, 2004 compared to $0.7million used in operating activities in the three months ended February 28,2003.  This increase in cash flowsprovided was primarily due to delayed payments to vendors in fiscal 2004partially offset by increased accrued expenses.  The cash used in fiscal 2003 was primarily due to increases inaccounts receivable and inventories. 

 

Cash flows used in investingactivities were $0.2 million in the three months ended February 29, 2004compared to $0.1 million in the three months ended February 28, 2003.  Cash flows used in fiscal 2004 included $0.2million in capital expenditures.

 

Cash flows used in financingactivities decreased by $10,000 to $8,000 in the three months ended February29, 2004 compared to cash flows used in financing activities of $18,000 in thethree months ended February 28, 2003. The decrease in cash used in financing activities primarily resultedfrom the payment of the note payable in fiscal 2003, partially offset by thepurchase of treasury stock in fiscal 2004.

 

16

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We have a $5.0 million line-of-creditagreement with Comerica Bank.  As ofFebruary 29, 2004, there were no borrowings outstanding against the line ofcredit.  Borrowings under the line ofcredit bear interest at the lesser of the bank’s reference rate (4.00 % atFebruary 29, 2004) less 0.25% or the bank’s LIBOR rate (1.10 % at February 29,2004) plus 2% and are limited to 80% of eligible accounts receivable and 50% ofeligible inventories if total liabilities to tangible effective net worth isgreater than two to one.  No formula isrequired if total liabilities to tangible effective net worth is less than twoto one. In connection with the line-of-credit agreement, we have a $650,000standby letter-of-credit sub-limit, of which approximately $80,000 wasoutstanding at February 29, 2004.  Thisline of credit is secured by substantially all of our assets.  Our borrowing arrangement requires us tocomply with certain financial covenants and other restrictions, including ourability to pay dividends and as of February 29, 2004 we were in compliance withthose covenants. As of February 29, 2004, we had approximately $4.9 million inavailability under the line of credit. The line-of-credit borrowings are due on demand. The agreement may beterminated by either party.

 

We believe that existing cashbalances of $2.6 million, our investments of $8.0 million, cash generated byoperating activities, and funds available under our credit facility will besufficient to finance our operating activities for at least the next 12 months,which will include capital expenditures of approximately $0.5 million.  To the extent that the funds generated fromthese sources are insufficient to finance our operating activities, we wouldneed to raise additional funds through public or private financing.  We cannot assure you that additionalfinancing, if required, will be available on terms favorable to us, or at all.

 

In March 2001, TROY established astock repurchase program under which TROY’s common stock, with an aggregatemarket value up to $4.0 million, may be acquired in the open market.  As of February 29, 2004, TROY had purchasedapproximately 334,293 shares of common stock in the open market under thisstock repurchase program, at an average price of $3.63 per share.  In February 2004, Troy retired 331,493shares purchased under the program. Approximately $2.8 million remains available for future common stock repurchases.

 

**Critical AccountingPolicies and Estimates**

 

# ***Application of Critical Accounting Policies***

# ** **

Critical accountingpolicies are defined as those that are the most important to the accurateportrayal of our financial condition and results of operations. Criticalaccounting policies require management’s subjective judgment and may producematerially different results under different assumptions and conditions. Ouroperations are affected by numerous factors including continued demand forprinted documents, development and market acceptance of wireless products,changes in technologies and new laws and government regulations andpolicies.  We cannot predict whatimpact, 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, thecarrying value and fair value of long-lived and intangible assets and the realizabilityof deferred tax assets. The following are our critical accounting policies:

 

*Inventories*

 

We value inventories at the lower ofcost or market on a first-in, first-out basis. We use a standard 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 based upon assumptions

 

17

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aboutfuture demand 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 mixof products in inventory, customer preferences and economic conditions and as aresult, additional write-downs may be required.

 

## ***Capitalization of softwaredevelopment costs***

## ** **

Costsincurred in the research, design and development of software for sale to othersas a separate product or embedded in a product and sold as part of the productas a whole are charged to expense until technological feasibility isestablished.  Thereafter, softwaredevelopment costs are capitalized until the products are offered for sale, andamortized to product cost of sales on a straight-line basis over the lesser offive years or the estimated economic lives of the respective products,beginning when the products are offered for sale. At each balancesheet date, we compare the unamortized capitalized costs to the net realizablevalue of that product. The net realizable value is the estimated future grossrevenues from that product reduced by the estimated future costs of completingand disposing of that product, including the costs of performing maintenanceand customer support required to satisfy our responsibility set forth at thetime of sale. For developed software components of a product or processmarketed 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.

 

*Long-lived and intangible assets*

 

Depreciationand amortization of our long-lived assets is provided using the straight-linemethod over their estimated useful lives. Changes in circumstances such as thepassage of new laws or changes in regulations, technological advances, changesto our business model or changes in the capital strategy could result in theactual useful lives differing from initial estimates. In those cases where wedetermine that the useful life of a long-lived asset should be revised, we willdepreciate the net book value in excess of the estimated residual value overits revised remaining useful life. Factors such as changes in the planned useof equipment, customer attrition, contractual amendments or mandated regulatoryrequirements could result in shortened useful lives.

 

We periodically review the value ofour long-lived tangible and our amortizing intangible assets to determine ifimpairment has occurred by comparing the carrying value of the long-livedassets with the lowest level of identifiable future net undiscounted cash flowsexpected to result from the use of the assets, including cash flows fromdisposition.  As discussed in Note 14 tothe consolidated financial statements in our annual report on Form 10-K for thefiscal year ended November 30, 2003, we recorded an impairment loss on certainlong-lived assets during fiscal year 2001 based on an evaluation of projectedoperating income, cash flows and business prospects. In addition, we determinedother long-lived assets were not impaired. In making these determinations, theassumptions used by management about future cash flows are critical.  If these expected cash flows are notrealized, future additional impairment losses may be recorded.

 

*Goodwill and Other Intangible Assets*

 

We adoptedStatement of Financial Accounting Standards (SFAS) No. 142 *Goodwill and Other Intangible Assets*effective December 1, 2002 and performed our initial transitionalimpairment test as of that date. The provisions of SFAS No. 142 requirethat we allocate our goodwill to our various reporting

 

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units, determine the carrying valueof those businesses, and estimate the fair value of thereporting units so that a two-step goodwill impairment test can be performed.Our reporting units represent components of our operating segments, which arethe same as the reportable segments, identified in Note 9. In the firststep of the goodwill impairment test, the fair value of each reporting unit iscompared to its carrying value. If the fair value exceeds the carrying value,goodwill is not impaired and no further testing is performed. If the carryingvalue exceeds the fair value, then the second step must be performed, and theimplied fair value of the reporting unit’s goodwill must be determined andcompared to the carrying value of the goodwill for the reporting unit. If thecarrying value of a reporting unit’s goodwill exceeds its implied fair value,then an impairment loss equal to the difference is recorded. For the year endedNovember 30, 2003, no impairment loss was recognized.  Our annual impairment testing date is the beginning of the fiscalfourth quarter, which is September 1.

 

*Evaluation of long-lived and intangible assets*

 

For long-lived assets, other thangoodwill, Financial Accounting Standards Board (FASB) Statement of FinancialAccounting Standards (SFAS) No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*, requires theevaluation for impairment whenever events or changes in circumstances haveindicated that an asset may not be recoverable. Long-lived assets evaluated forimpairment are grouped with other assets to the lowest level for whichidentifiable cash flows are largely independent of the cash flows of othergroups of assets and liabilities. If the sum of the projected undiscounted cashflows (excluding interest charges) is less than the carrying value of theassets, the assets will be written down to the estimated fair value, and theloss recognized in income from continuing operations in the period in which thedetermination is made. Management has determined that no impairment oflong-lived assets existed at November 30, 2003.

 

*Revenue recognition*

 

We recognize revenue from the sale ofour check printing equipment and supplies and print servers to end users,distributors, original equipment manufacturers (OEM) and resellers when theprice is fixed and determinable, the product is shipped and the title istransferred to the buyer, with economic substance, net of an allowance forestimated returns, as long as no significant post-delivery obligations existand collection of the resulting receivable is probable and not contingent onresale of the product. Revenue from equipment maintenance contracts on checkprinting equipment and print servers is recorded as deferred income when billedand is recognized straight-line over the term of the contract.  We provide for estimated reserves based uponour historical rates of returns and allowances.  Actual returns in any future period are inherently uncertain andthus may differ from our estimates.  Weaccrue for warranty expense at the time revenue is recognized and maintain awarranty accrual for estimated future warranty obligations based upon therelationship between historical and anticipated warranty costs and salesvolumes.  To the extent we experienceincreased warranty claim activity or increased costs associated with servicingthose claims, our warranty accrual will increase resulting in decreased grossprofit.

 

We recognize revenue from softwarearrangements of our StarACHTM software in accordance with Statement of Position(“SOP”) 97-2, *Software Revenue Recognition*as amended by SOP 98-9, *Modification of SOP97-2 with Respect to Certain Transactions*. Revenue is recognizedwhen persuasive evidence of an arrangement exists and delivery has occurred,provided the fee is fixed or determinable, collectibility is probable and thearrangement does not require significant customization or modification of thesoftware.  For arrangements where thesoftware requires significant customization or modification, we recognizerevenue for the software license and consulting services portion of thearrangement using the completed contract method of accounting under SOP 81-1.Contracts are considered complete upon

 

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customeracceptance.  Maintenance revenue for theStarACHTM software is recognized ratably over the term of the maintenancecontract, typically 12 months.

 

Revenue from software licenseagreements with OEMs for print servers whereby we provide ongoing support overthe term of the contract is recognized when the licensed software isincorporated into the OEMs’ products.

 

*Allowance for doubtful accounts*

 

We maintain an allowance for doubtfulaccounts for estimated losses resulting from the inability of our customers tomake required payments.  The amount ofthe reserve is based on historical experience and our analysis of the accountsreceivable outstanding.  If thefinancial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired which would result in an additional expense in the period suchdetermination was made.

 

*Off-balance sheet financings and liabilities*

 

Other than lease commitments andlegal contingencies incurred in the normal course of business, we do not haveany off-balance sheet financing arrangements or liabilities.  We do not have any majority-ownedsubsidiaries or any interests in, or relationships with, any materialspecial-purpose entities that are not included in the consolidated financialstatements, except for a related party lease arrangement.

 

*Comprehensive Income*

 

Management has determined that thefunctional currency of its foreign subsidiary located in Canada is the localcurrency, while the functional currency of its foreign subsidiary located inGermany is the U.S. dollar. Assets and liabilities of our foreign subsidiarywhose local currency is the functional currency are translated into U.S. dollarsat the period-end exchange rates. Income and expenses are translated at theaverage exchange rate for the period and the resulting translation adjustmentsare accumulated as a separate component of stockholders’ equity, which totaled$18,000 and $33,000 at February 29, 2004 and November 30, 2003,respectively. The German subsidiary’s financial statements are remeasured atmonth-end exchange rates for monetary assets and liabilities, and historicalexchange rates for nonmonetary assets and liabilities and equity. Income andexpenses are translated at the average exchange rate for the period, andtranslation adjustments are included in income for foreign entities whosefunctional currency is the U.S. dollar. Foreign currency gains and losses fromtransactions denominated in other than respective local currencies are includedin income.

 

*Income taxes*

 

Deferred taxes are provided on a liabilitymethod whereby deferred tax assets are recognized for deductible temporarydifferences, and operating loss and tax credit carryforwards and deferred taxliabilities 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 andprudent and feasible tax planning strategies. We have placed substantialreliance on our current projections of future taxable income.  We re-assess our projections of taxableincome on a quarterly basis.  If it isdetermined that we would not be able to realize all or part of our deferred taxassets in the future, which would include our failure to materially meet ourprojections of taxable income, an adjustment to the carrying value of thedeferred tax assets would be charged to income in the period in which suchdetermination was made and may affect our annual effective income tax rate. 

 

We currently believe the deferred tax assetsare more likely than not to be realized based on current expectations of futureearnings and available tax planning strategies.  Deferred tax assets and liabilities are adjusted for the effectsof changes in tax laws and rates on the date of enactment.

 

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*Stock-based compensation*

 

As allowed by Statement of FinancialAccounting Standards (SFAS) No. 123, we have elected to continue to account forour employee stock-based compensation plan using the intrinsic value method inaccordance with Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees, and relatedInterpretations*, which does not require compensation to be recordedif the consideration to be received is at least equal to the fair value of thecommon stock to be received at the measurement date. Nonemployee stock-basedtransactions are accounted for under the requirements of SFAS No. 123, *Accounting for Stock-Based Compensation*,which requires compensation to be recorded based on the fair value of thesecurities issued or the services received, whichever is more reliablymeasurable.

 

**Recent Accounting Pronouncements**

 

In May 2003 FASB issued Statement ofFinancial Accounting Standards (SFAS) No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*, which requires that certain financial instruments previouslypresented as equity or temporary equity be presented as liabilities.  Such instruments include mandatoryredeemable preferred and common stock, and certain options and warrants.  SFAS No.150 is effective for financialinstruments issued, entered into or modified after May 31, 2003 and isgenerally effective at the beginning of the first interim period beginningafter June 15, 2003.  The adoption ofSFAS No.150 is not expected to have a material effect on the Company’s financialposition or results of its operations.

 

In 2003, the Financial AccountingStandards Board issued FASB Interpretation No. 46 (FIN 46), *Consolidation of Variable Interest Entities, anInterpretation of Accounting Research Bulletin No. 51*, asrevised. Prior to FIN 46, a company generally included another entity in thecompany’s financial statements only if it controlled the entity throughownership of the majority voting interests. FIN 46 requires certain variable interest entities to be consolidated bythe primary beneficiary of the entity if the equity investors in the entity donot have the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties. FIN 46 iseffective for the Company for all variable interest entities beginning thequarter ending May 31, 2004. We are currently analyzing the effect that theadoption of FIN 46 will have on our results of operations and financialposition, but expect that upon the implementation date, it is reasonablypossible that we will be required to consolidate the related party leasingentity described Note 10 to our consolidated financial statements in our annualreport on Form 10-K for the fiscal year ended November 30, 2003.

 

The financial statements of therelated party leasing entity for the year ended November 30, 2003 are currentlynot available; however, management estimates that if this entity is required tobe consolidated 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.

 

# **CERTAIN IMPORTANT FACTORS**

 

There are several important factorsthat could cause our actual results to differ materially from those weanticipate or those reflected in any of our forward-looking statements.  These factors, and their

 

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impacton the success of our operations and our ability to achieve our goals, include,but are not limited to, those set forth below.

 

**Our business depends on the continued demand for printeddocuments, including financial documents.**

 

Because we provide solutions thatallow enterprises to distribute and print information, our business depends inlarge part 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.

 

**Although we have re-engineeredcertain of our wired connectivity products in a manner that we believewill extend their useful life, there can be no assurance that this will be thecase.**

 

Although we have re-engineeredcertain of our wired connectivity products in a manner that we believe willextend their useful lives, there can be no assurance that this will be thecase.  Should these changes not extendthe useful life of these products, we anticipate that sales of these productswill begin to decline, in which case it would be necessary for us to offsetthis potential decline through increased sales of other products.  There is no assurance that we will besuccessful in achieving increased sales in other products.

 

**The success of our wireless solutionsdepends on our ability to develop and introduce on a timely basis new productsfor existing and emerging wireless communications markets and the ability ofthese products to gain market acceptance.**

 

The development of new wirelessnetworking products is highly complex, and we may experience delays indeveloping 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 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.

 

**Technology in our industry evolvesrapidly, and we must continue to enhance existing products and develop newproducts or our business will suffer.**

 

Rapid technological advances, obsolescenceand large fluctuations in demand and changing industry standards characterizethe markets for our current products. Our existing and development-stage products may easily become obsoleteif our competitors introduce newer or better technologies or if industrystandards change.  To be successful, wemust continually enhance our existing products and develop and introduce othersecure payment system products and wireless and connectivity products.  If

 

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we failto adequately anticipate or respond to changing technological developments andstandards or customer requirements, or if we are significantly delayed indeveloping and introducing products, our business will suffer.  In addition, our success in this rapidlychanging environment depends on our ability to appropriately refocus ourmanagement attention and other resources on the emerging technologies andstandards that will ultimately gain market acceptance.

 

**We face significant competition that may negatively impactour revenues, gross margins and market share.**

 

We face increased competition indeveloping and selling secure payment systems as well as our wireless andconnectivity solutions.  Many of ourcompetitors in this market have substantially greater financial, development,marketing and personnel resources than we have.  We cannot assure you that we will be able to compete successfullyagainst our current or future competitors. Increased competition may result in price reductions, lower grossmargins and loss of market share.

 

**We maintain strategic supply, OEM and marketing arrangements,and termination of these relationships could adversely affect our revenues andearnings.**

 

We maintain and depend on strategicrelationships with a number of companies, including Certegy, HP, IBM, Novell,and Standard Register.  Theserelationships include supply, OEM, marketing and service arrangements which areimportant to our business.  Certain ofthese relationships are not covered by written agreements and could beterminated at any time.  If ourrelationship with any of these companies were to end, our revenues and earningscould fall.  We cannot assure you thatwe will be able to maintain our strategic relationships with these companies.

 

**We sell a significant portion of our productsinternationally, which exposes us to currency fluctuations and other risks.**

 

We sell a significant amount of ourproducts to customers outside the United States.  International sales accounted for 20.9% of our net sales in thethree months ended February 29, 2004 and represented 19.8% of our net sales inthe three months ended February 28, 2003. We expect that shipments to international customers will continue toaccount for a material portion of our net sales.  Sales outside the United States involve the following risks,among others:

 

•                  foreign governments may impose tariffs,quotas and taxes;

 

•                  political and economic instability mayreduce demand for our products;

 

•                  restrictions on the export or import oftechnology may reduce or eliminate our ability to sell in certain markets; and

 

•                  potentially limited intellectual propertyprotection may cause us to refrain from selling in certain markets.

 

Because we denominate some of ourinternational sales in U.S. dollars, currency fluctuations could also cause ourproducts to become less affordable or less price-competitive than those offoreign manufacturers.  We cannot assureyou that these factors will not have a material adverse effect on ourinternational sales.  Any adverse impacton our international sales would affect our results of operations and wouldcause our business to suffer.  Inaddition, currency fluctuations could result in transaction or translationgains or losses which could have an effect on our net sales and profits.

 

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**Our quarterly operating results fluctuate as a result of manyfactors.**

 

Our quarterly operating resultsfluctuate due to various factors.  Someof the factors that influence our quarterly operating results include:

 

•                  the mix of products and services sold inthe quarter;

 

•                  life-cycle stages of the products sold inthe quarter;

 

•                  the availability and cost of componentsand materials;

 

•                  costs and benefits of new product andservice introductions; and

 

•                  customer order and shipment timing.

 

Because of these factors, ourquarterly operating results are difficult to predict and are likely to vary inthe future.  If our revenues or earningsare below expectations in any quarter, our stock price is likely to drop.

 

**Patrick J. Dirk and his family members beneficially ownapproximately 67% of our common stock and this concentration of ownershipallows them to control all matters requiring stockholder approval, could delayor prevent a change in control of TROY and limits the trading volume for ourshares.**

 

Patrick J. Dirk and hisfamily members beneficially own approximately 67% of our outstanding commonstock. As a result, Mr. Dirk and his family members are able to control allmatters requiring stockholder approval, including election of directors, andcould delay or prevent a change in control of TROY.  In addition, because of the significant percentage of outstandingshares beneficially owned by Mr. Dirk and his family members and the fact thatthey have not historically traded their shares to any significant extent, thetrading volume for shares of our common stock has been, and continues to be,limited.  As a result, many stockholdersmay not be able to sell their shares without a significant impact on the marketprice of our common stock.

 

**We may not be able to adequately protect or enforce ourintellectual property rights or to protect ourselves against infringementclaims of others.**

 

We cannot be certain that the stepswe have taken to protect our intellectual property rights will be adequate orthat third parties will not infringe or misappropriate our proprietaryrights.  Any such infringement ormisappropriation could have a material adverse effect on our future financialresults.  We also cannot be certain thatwe have not infringed the proprietary rights of others.  Any such infringement could cause thirdparties to bring claims against us, resulting in significant costs, possibledamages and substantial uncertainty.

 

**We depend on our executive officers for our success.**

 

We are significantly dependent uponPatrick J. Dirk, our Chairman and Chief Executive Officer, and our otherexecutive officers.  There could be amaterial adverse effect on our business if we lose the services of Mr. Dirk orany other executive officer.

 

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**Compliance with government regulations may cause us to incurunforeseen expenses.**

 

Our MICR printer and imaging suppliesmanufacturing operations are subject to a number of federal, state and locallaws and regulations.  These regulationsinclude laws and regulations promulgated by the Environmental Protection Agencyand similar state agencies regarding storing, shipping, disposing, dischargingand manufacturing hazardous materials and hazardous and non-hazardouswaste.  Although we believe that ouroperations materially comply with all current laws and regulations, we cannotassure you that these regulations will not change.  We also cannot assure you that unforeseen environmental incidentswill not occur, or that past contamination or non-compliance with environmentallaws will not be discovered on our current or former properties.  Any of these events could result insignificant expense or require changes in our operations, which couldmaterially and adversely affect our business.

 

**ITEM 3.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Marketrisk is the risk of loss to future earnings, to fair values or to future cashflows that may 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 utilize derivativefinancial instruments.  Accordingly, ourexposure to market risk is through our foreign currency transactions andthrough our bank debt which bears interest at variable rates.    We do not hedge our exposure to foreigncurrency fluctuations. Rather, we monitor our foreign currency exposure on amonthly basis.  Principal foreigncurrencies are the Euro and the Canadian Dollar.  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 (4.00 % at February 29,2004) less 0.25% or the bank’s LIBOR rate (1.10 % at February 29, 2004) plus 2%and are limited to 80% of eligible accounts receivable and 50% of February 29,2004, 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.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**(a)****Evaluation of disclosure controls and procedures.**We maintain “disclosure controls and procedures,” as such term is definedin Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”), that are designed to ensure that information required to be disclosed byus in reports that we file or submit under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified inSecurities and Exchange Commission rules and forms and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure. In designing and evaluating our disclosurecontrols and procedures, management recognized that disclosure controls andprocedures, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the disclosurecontrols and procedures are met. Additionally, in designing disclosure controlsand procedures, our management necessarily was required to apply its judgmentin evaluating the cost-benefit relationship of possible disclosure controls andprocedures. The design of any disclosure controls and procedures also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions. In the first quarter of fiscal 2004, we began the implementationof a new ERP system.  Although this newERP system has not yet been fully implemented, we expect that, once fullyimplemented, it will improve our overall disclosure controls and procedures.

 

  Based on their evaluation as of the end ofthe period covered by this Quarterly Report on Form 10-Q, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that, subject to the

 

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limitations noted above, ourdisclosure controls and procedures were effective to ensure that materialinformation relating to TROY is made known to them by others, particularlyduring the period in which this Quarterly Report on Form 10-Q was beingprepared.

 

**  (b)****Changes in internal controls.**Therewas no change in our internal control over financial reporting (as defined inRule 13a-15(f) under the Exchange Act) identified in connection with theevaluation described in Item 4(a) above that occurred during our last fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting. In the first fiscalquarter of 2004, we began the implementation of a new ERP system.  Although this new ERP system has not yetbeen fully implemented, we expect that, once fully implemented, it will improveour internal controls over financial reporting.

 

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**PART II:  OTHERINFORMATION**

 

**ITEM 1 - LEGAL PROCEEDINGS**

 

On November 21, 2002, Tom Lloyd filedan action in the Superior Court of the State of California in and for OrangeCounty against TROY and its directors, alleging that defendants breached theirfiduciary duties in connection with the Merger by attempting to provide theDirk family with preferential treatment in connection with their efforts tocomplete a sale of TROY. The complaint sought to enjoin an acquisition of TROYby the Dirk family, as well as attorneys’ fees. Following termination of theMerger Agreement, the plaintiff filed a motion for dismissal of the action andaward of attorney’s fees and expenses of $387,250.  TROY filed a motion in support of the plaintiff’s motion fordismissal of the action and in opposition to plaintiff’s motion for fees.  On March 4, 2004 the court issued a rulinggranting the motion for dismissal with prejudice, and granting the motion forattorney’s fees of $175,000. On April 30, 2004, TROY filed a notice of appeal.TROY has accrued an estimate of expenses to be incurred in connection with thislitigation in fiscal 2003 in excess of the deductible amount, which wasrecorded as an expense in fiscal 2002.

 

**ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Our Annual Meeting of Stockholders was held on March 29,2004.  The following individuals wereelected at the Annual Meeting as Directors of TROY to serve until the nextannual meeting or until their respective successors are elected andqualified.  Shares voted in favor ofthese Directors and shares withheld were as follows:

 
| **Director**       |   | **Shares For** |   | **Shares Withheld** |   |
|--------------------|--------|----------------|--------|---------------------|--------|
|               |   |           |   |                |   |
| Patrick  J. Dirk   |   | 9,766,409      |   | 479,146             |   |
| Brian  P. Dirk     |   | 9,766,409      |   | 479,146             |   |
| Gene  A. Bier      |   | 10,078,481     |   | 166,874             |   |
| Stephen  G. Holmes |   | 10,078,481     |   | 166,874             |   |
| Lambert  Gerhart   |   | 10,078,481     |   | 166,874             |   |

 

**ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits.

 
| **Exhibit  Number** |   | **Description**                                                                                          |
|---------------------|--------|----------------------------------------------------------------------------------------------------------|
| 31.1                |   | Rule 13a-14(a) Certification of  Chief Executive Officer.                                                |
|                |   |                                                                                                     |
| 31.2                |   | Rule 13a-14(a) Certification of  Chief Financial Officer.                                                |
|                |   |                                                                                                     |
| 32.1                |   | Certification of the Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                     |
| 32.2                |   | Certification of the Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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(b)                                 Reportson Form 8-K

 

OnFebruary 23, 2004, we furnished a Current Report on Form 8-K dated February 13,2004 under Item 12. regarding a press release announcing our financial resultsfor the fourth quarter and fiscal year ended November 30, 2003.

 

The Company issued a Current Report on Form 8-K dated March 22, 2004,as amended on Form 8-K/A dated April 2, 2004, both under Item 4.,  regarding the Audit Committee of our Boardof Directors’ approval of a change in our independent accountants for thefiscal year ending November 30, 2004. The Board of Directors ratified the Audit Committees’ dismissal ofMcGladrey & Pullen, LLP and the selection of BDO Seidman, LLP as ourindependent accountants.  The report ofMcGladrey & Pullen for the fiscal years ended November 30, 2003 andNovember 30, 2002, contained no adverse opinions, disclaimer of opinion orqualification or modification as to uncertainty, audit scope or accountingprinciples.

 

During the fiscal years ended November 30, 2003 and November 30, 2002and the subsequent interim period through the date hereof, there were nodisagreements between the Registrant and McGladrey & Pullen on any matterof accounting principles or practices, financial statement disclosure orauditing scope or procedure, which disagreements, if not resolved to thesatisfaction of McGladrey & Pullen, would have caused it to make referenceto the subject matter of the disagreement in connection with its report.  No reportable event described in paragraph(a)(1)(v) of Item 304 of Regulation S-K has occurred within the Registrant’sfiscal years ending November 30, 2003 and November 30, 2002.

 

The Registrant did not consult with BDO Seidman, LLP during the fiscalyears ended November 30, 2003 and November 30, 2002, with respect to theapplication of accounting principles to a specified transaction, eithercompleted or proposed, or the type of audit opinion that might be rendered onthe Registrant’s consolidated financial statements, or any other matters orreportable events as set forth in paragraphs (a)(2)(i) and (ii) of Item 304Regulation S-K.

 

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**SIGNATURES**

** **

Pursuant tothe requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|         | TROY GROUP,  INC.                                               |
|--------------|-----------------------------------------------------------------|
|         |                                                            |
|         |                                                            |
| May 12, 2004 |                                                            | /s/ Patrick  J. Dirk |
|         | Patrick J.  Dirk                                                |
|         | Chairman,  President and Chief Executive Officer                |
|         |                                                            |
| May 12, 2004 |                                                            | /s/ James W.  Klingler |
|         | James W.  Klingler                                              |
|         | Vice  President-Finance, Treasurer and Chief  Financial Officer |

 

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**EXHIBIT INDEX**

 

 
| **Exhibit  Number** |   | **Description  of Document**                                                                             |
|---------------------|--------|----------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                     |
| 31.1                |   | Rule 13a-14(a) Certification of Chief Executive  Officer.                                                |
|                |   |                                                                                                     |
| 31.2                |   | Rule 13a-14(a) Certification of Chief Financial  Officer.                                                |
|                |   |                                                                                                     |
| 32.1                |   | Certification of the Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                     |
| 32.2                |   | Certification of the Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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